Scottish Economy Watch

Scotland is not Slovakia

It was reported in the Scotsman on Wednesday that the President of the Czech Republic Vaclav Klaus had raised doubts that an independent Scotland could successfully keep using the British pound. This was because when Czechoslovakia split into the Czech and Slovak Republics in 1993 it took only 38 days for the currency union to split.

His views led to a rush of comments from supporters of the UK union arguing that a currency union is only possible with political union. Then a spokesman from the Treasury asserted that protectionism grew between the Czech Republic and the Slovak Republic after the split. The evidence cited by the Treasury spokesman was the fall in Slovak exports to the Czech Republic from 42 per cent of all exports to 13 per cent between 1993 and 2003. Conversely, Czech Republic exports to the Slovak Republic fell from 22 per cent of total exports to 8 per cent. He noted ominously that currently 59 per cent of Scottish exports are to the rest of the UK.

While the basic facts cited are correct, the interpretations put on them by Vaclav Klaus and the UK Treasury spokesman are, shall we say, at odds with the truth.

Scotland in 2012 or 2014 is not the Slovakia of 1992 or 1993.

First, Czechoslovakia was a planned economy, part of the Soviet bloc that practised autarky and state direction of production and resources. At the time of the split, the eastern bloc had dissolved and the two new states were seeking to become market economies increasing their trade and other economic links with the wider world.

Slovakia was much the weaker state, heavily dependent on resource transfers from Czech, with GDP per head 76 per cent of Czech figure, having risen with the help of a state policy promoting convergence, while labour productivity stood at around 89 per cent of the Czech figure as this table shows:

Note also from the table that wages were much closer at 97 per cent of the Czech average monthly wage. Hence, Slovaks were consuming much more than they were producing. This leads on to the second key fact about the Czechs and Slovaks.

Prior to the split, the extent of resource transfer from Czech land to the Slovak lands was about 11 per cent of Slovak GDP and about 4 per cent of Czech GDP - see this very informative research paper by Růžena Vintrová in 2009 from which the above table is taken. The transfer of resources was outstripping the Czech rate of growth and this is one reason why many Czechs wanted rid of Slovakia.

Now, while there is a sizable transfer of resources to Scotland from rest of UK, this is only the case if you do not allocate to Scotland a geographical share of oil revenues. And the average size of Scotland's fiscal deficit, if a population share rather than geographical share of oil revenues is assigned, is 6.5 per cent since 1990. With a geographical share there is still a deficit of 3.6 percent since 1990 but this is much less than 11 per cent - see my earlier post here.

So, the reason why the Slovak Republic chose a 10 per cent one-off devaluation thereby breaking the currency link to the Czech Republic was because as an independent country it was consuming beyond its means, running a large current account trading deficit and a large effective fiscal deficit. Given its low productivity the devaluation was necessary to reduce domestic real wages and get unit labour costs down to more competitive levels.

Further depreciation against the Czech koruna occurred in later years. Slovak wages started to fall relative to wages in the Czech Republic. From almost parity in 1993 at 3 per cent below to 30 per cent below in 2007. This policy was largely successful as the Slovak economy began to diversify away from heavy industry and armament production to new forms of competitive advantage such as motor vehicle production. A diversification based on trade, low wages and imported foreign technologies.

The result of these adjustments was a rapidly growing economy, more diversified and trading with many countries, especially Germany, compared to the pre-split centrally planned days. Hence trade with the Czech Republic fell for growth and market reasons mainly and had little do with a rise in protectionism. This was further facilitated by entry to the EU in 2004.

So, Scotland is not Slovakia. With a geographical share of oil revenues Scotland is close to paying its way, labour productivity levels are almost identical to the UK - see here - although total factor productivity growth could be somewhat lower. Moreover, Scotland is a well developed market economy trading with many nations not a centrally planned, autarkic state.

For these reasons it makes sense for Scotland, if independent, to stick with sterling. A rise in protectionism between an independent Scotland and a rest of the UK state is possible in subtle ways that might circumvent the EU single market. But my judgement is that it would not be great. It would be insufficient to undermine the rest of UK as Scotland's major trading partner and its integrated UK labour market and hence the justification for retaining sterling.

But as the oil revenues begin to run out an independent Scotland will need to raise its performance in manufacturing and tradable services. If productivity growth is insufficient to achieve this then that might be the time for the link with sterling to be broken. While if Scotland remains within the UK, the burden of such adjustment will be borne by the whole of the UK.

Labour Income Shares in the Scottish Economy

The STUC's valuable report A Just Scotland see here, raises many interesting questions which the two campaigns for and against independence need to address. One issue they raise in the report is the labour market and the lack of a debate on the likely structure and regulation of the labour market in different constitutional scenarios.

The STUC clearly fears that the current UK approach favouring flexible labour markets has been accepted by both sides of the constitutional debate when they believe the issue should be debated.

I agree.

The STUC argue that flexible labour markets produce "an economy where work is less well paid, less secure and less permanent." In addition, they note the "completely overlooked" macroeconomic consequence of a falling wage share, which, they go on to suggest:

If the wage share in the economy of an independent Scotland continues to fall then the only way in which the products and services the economy produces can be consumed is through rising debt. This hardly provides for the foundations of a stable, prosperous society. (Page 13)

While welcoming further debate, I think the issue is a little more complicated than this.

First, there is an issue about flexibility. A labour market lacking in regulation seems certain to produce 'sweat shop' conditions, low wages and insecurity. Conversely, a labour market that is heavily regulated seems likely to lead to high hiring costs and low job creation. I'd like to see what the evidence shows on this.

The issue then is can we find an 'optimal' degree of labour market regulation and flexibility that protects workers from vindictive and exploitative employers, while at the same incentivising firms to hire workers and so create jobs? That is the question where I would like to see more theory, evidence and debate.

Secondly, the data on labour shares do not, as far as I can tell, support a view that labour's share of income has been consistently falling in Scotland. The latest Scottish National Accounts Project (SNAP) - experimental - data on compensation of employees is shown in the chart below

Clearly, the data only start in 1998 so I am not sure if the share was falling during the 1990s after the so-called 'Thatcher revolution'. But what the SNAP data show is a rising labour share from 59 per cent to 66 per cent between 1998 and 2001. Then the share fell gently to 62% at the beginning of 2008 when the recession was beginning to bite. During the recession and after the share has oscillated around 63 per cent.

So there is no downward trend during this period of data and other factors seem to be in play as a determinant of labour income share in addition to the UK's fairly flexible labour market regime.

The STUC and Scottish Independence

Today the Scottish Trades Union Congress published A Just Scotland an interim report on Scotland's constitutional future. The report is well worth reading by any fair minded individual wishing to understand the issues and unanswered questions surrounding the independence debate. Some hard questions are asked of both the 'Yes' and 'Better Together' campaigns. The STUC wisely takes a neutral stance on the issue for the moment, until the two campaigns respond to its challenges and provide some answers to its questions.

I thoroughly support the STUC's position and I would go further and stress openly that both campaigns need to raise their game. They can begin by responding constructively to the challenges and questions laid down in A Just Scotland.

The IFS and Scottish Independence

The new report by the independent Institute for Fiscal Studies (IFS) on the fiscal context of Scottish independence is to be welcomed. The report is published today and will be presented to the David Hume Institute Autumn Seminar Series this evening.

However, there is little that is fundamentally new in the report compared to the analyses already published by CPPR and - dare I say it - this blog here, here and here.

But it does provide more precision on Scotland's fiscal position in the run up to the referendum and possibly thereafter. This is achieved by a thorough appraisal of the UK's fiscal position and Scotland's relation to it. The report's presentation of the nuts and bolts of Scotland's public finances is also illuminating and more so than Government Expenditure and Revenues Scotland (GERS) from which it draws much of its data.

Its findings are neatly summed up by one of the report's authors, David Phillips, who suggests that

Independence would provide Scotland with an opportunity to set its own fiscal course. In common with all countries it would face constraints and would have to make, sometimes uncomfortable, choices. In the short run its higher public spending than the UK average could be covered by oil and gas revenues if these are assigned on a geographic basis. In the longer run the loss of these revenues would lead to tougher choices than those faced by the UK as a whole.

The reasons offered for a more difficult long-run fiscal position than the UK is the expected marked fall in oil revenues, the volatility of oil revenues and a worse demographic position associated with a rising dependency ratio due to a more rapidly ageing population.

The report notes that the borrowing costs faced by an independent Scottish government "will be a very important question for the sustainability of the Scottish public finances." But doesn't go as far as asserting that these costs will definitely be higher, something that the present Scottish government will be grateful for.

The IFS argue that the new government's borrowing costs would depend on factors such as the announced fiscal stance of the government, its perceived credibility and many other economic decisions. It notes that the UK government has low borrowing costs and implies that Scotland would not have such low costs unless it adopts a similar tight fiscal stance and gains the same degree of credibility.

But since the IFS does not deal with monetary policy issues the Institute fails to consider why Scotland might have higher borrowing costs due to an independent Scotland borrowing in a foreign currency and being unable to print its own currency (i.e. through the adoption of sterling or the euro), or would lack any initial monetary policy credibility if it did adopt its own currency straight away.

The report is also clear that it is solely focusing on fiscal policy and so is ignoring other economic policies such as industrial policy, and regulation. That is important, because if you are a nationalist you might believe that an independent Scotland will enable a more radical growth enhancing industrial policy to be introduced. Such a policy, if successful at raising the growth rate would narrow the fiscal gap that IFS see emerging as oil revenues decline and demographic factors kick in. Readers will know that I have my doubts about the likelihood of such a policy but it cannot be ignored and its feasibility needs to be examined and debated.

By eschewing consideration of policy other than fiscal policy the report also misses other possibilities that could mitigate the probable difficult fiscal situation in an independent Scotland. So, for example, a more open migration policy would, if successful, attract in young migrants of working age. This would help boost the birth rate, raise the tax base and lower the dependency ratio. A separate macro-stabilisation policy under independence - or devolution plus - might help smooth the volatility of Scottish GDP, and minimise inflation. Both outcomes could help growth and the fiscal position.

This is a good report. It makes clear the fiscal realities that confront an independent Scotland. And it is a strong antidote to the SNP government's posturing that under independence each person in Scotland would be £500 better off.

The report does raise several questions about the future of fiscal policy in an independent Scotland and identifies the areas for further research. But there is also a need for a wider analysis and debate of the economic issues relating to Scottish independence.

 

Scottish entrepreneurial buzz, or needs must?

There seems to be a buzz. A buzz that Scotland has become more entrepreneurial. We have the exciting new website published by my good friend Bill Jamieson, Scot-Buzz. On Friday, in the Scotsman, the imaginative nationalist columnist George Kerevan, in a very partial use of statistics to defend both Scottish government policy and the robustness of the Scottish labour market, asserted

In the year to March 2012, the number of enterprises in Scotland increased by a record 10 per cent – fully 30,835 new firms. Not only was this the biggest annual increase since 2000, the growth in new enterprises in Scotland happened at roughly double the rate for the UK as a whole. .... this is hardly indicative that Scotland was under-performing compared to the UK as a whole.

And George Kerevan is correct. The data he uses come from the latest Businesses in Scotland publication which was published on 7 November.

Unfortunately, I do not believe that these data are sufficient to draw the conclusion that we have a new entrepreneurial buzz in Scotland, or that the Scottish economy and labour market is doing very well thank you.

First, we need to say a few words about the data. The businesses that comprise the database are registered and unregistered businesses. The registered businesses are those that are registered for VAT and/or PAYE. The unregistered businesses relate, in the words of the relevant Scottish government web page

a substantial number of very small enterprises which have no employees and operate below the VAT threshold, and are therefore not included on the IDBR (which contains the registered businesses). A modelling procedure that combines data from the IDBR with data from the Annual Population Survey (annual version of the Labour Force Survey (LFS)), Family Resources Survey (FRS) and HMRC Self Assessment tax returns are used to estimate the number of unregistered enterprises.

So, this is not a simple count. There is a lot of estimation and to be blunt: educated guesswork in the series, which nevertheless does have the National Statistic kite mark.

This is how the data look when we separate out the registered and unregistered businesses

Yes, it is the unregistered businesses that are growing. The registered business numbers have been fairly stable over the first decade of 2000s. And the recent jump between 2011 and 2012 is in part to do with HMRC discovering more firms - see here page 2. The statisticians have tried to adjust the earlier numbers to be comparable but there must clearly be a health warning as to whether we are really making a like-for-like comparison with the earlier years of registered businesses.

Now, it is clearly the growth of the unregistered businesses that is interesting. These are the ones with no employees and which are sufficiently small to have a turnover less than the VAT threshold - currently £77,000 per annum - and are not registered for PAYE. Most of them will not have business bank accounts either - see below.

Over the period 2000 to 2012 their numbers have grown by more than 90,000 or 99 per cent. The number basically doubled. But there was something of an acceleration after 2006 with nearly 60,000, or two-thirds, of the rise occurring during the years of recession and limited economic recovery. An even rate of growth would have delivered about 45,000.

While there is now a large body of theory and evidence linking increased entrepreneurship to growth - see here and here - one would also expect a growing economy to raise business opportunities and hence stimulate entrepreneurship - see here.

But what we appear to see in Scotland is an apparent rise in entrepreneurship that has had no effect on growth to date. And this has occurred when the economy has been contracting and stagnating.

A reasonable person might conclude that these data do not indicate that there has been an increase in entrepreneurship of any sizable magnitude in Scotland.

This conclusion is supported by the Scottish clearing bank data on the opening of business bank accounts, which is taken as a one proxy for entrepreneurship. The latest data are shown in this chart

No suggestion of an entrepreneurial resurgence in these data.

So what has been happening?

The answer I think lies in the weakness of the Scottish economy coupled to structural and demographic changes in the labour market favouring part-time, multiple job holding and self employment as this post shows. And also a growing awareness that tax bills can be legally reduced by creating companies and paying corporation tax instead of income tax. But while the creators of the companies may have several different income streams from individuals' portfolio work, they have no employees and can't in truth be considered to be 'proper' businesses.

The chart below shows what has been happening to full-time employment in Scotland.

It has been falling since 2007 and is over 7 percent below its 2007-2008 peak compared around 3 per cent for total employment. Many of these full-time workers that lost their jobs will have gone into self-employment and there is a significant evidence base from across the world to support this "recession-push" hypothesis - of being pushed into self-employment but not necessarily entrepreneurship - for example see here, and here.

The latter study, by Dawson, Henley and Latreille (2009), which analysed the UK labour force survey between 1999 and 2001, did not find much support for the 'push' hypothesis but drew this interesting conclusion

Whether this conclusion would be as robust during the current period of severe economic downturn and rapidly rising unemployment is open to debate and, with suitable data, further future analysis. Indeed it would give cause for considerable concern if the proportion choosing self-employment because it represents the only alternative to economic inactivity was to rise significantly in the next few years. Such 'forced' choices may not lay solid foundations for well-resourced, successful new business ventures.

Indeed. And that appears to be what we are witnessing in Scotland.

Needs must, not entrepreneurial buzz.

Scotland's unemployment differential (Revised)

A revision to the chart presented in this 18 October post. I should have included wage rates as an influence on the supply and demand of labour, which I did in the latest Commentary and now include here

Clearly, differential movement in wage rates between Scotland and the UK could affect both the demand and supply of labour. But we have no evidence so far that this is material in the Scotland - UK unemployment differential.

Where have all the jobs gone?

Today's labour market data highlight the continuing divergence between Scotland and the UK. The jobs market is clearly deteriorating in Scotland while apparently markedly improving in the UK. Employment in the UK rose by 100,000 in the quarter to July - September, an increase of 0.3 per cent. In contrast, Scottish jobs fell by 27,000 a drop of 1.1 per cent.

Looking back on employment since the recession we have the following jobs picture in Scotland and UK.

The UK jobs market has now returned to, and slightly passed, its pre-recession peak, whereas in Scotland employment is still 3.1 per cent below the peak.

These data suggest that output growth in Scotland will have been weaker in the third quarter and I think primarily because of the Olympic 'bounce' effect. Output might be stronger than these jobs figures imply because of the apparent labour productivity effect that has seen output hold up much better than both jobs and the volume of hours, which we noted in the recent Fraser of Allander Institute Commentary here.

But the overall labour market picture is worrying from a Scottish standpoint.

Unemployment continues to rise in Scotland as it falls in the UK. Unemployment rose by 4,000 in Scotland in the quarter to July - September, a rise of 1.8 per cent. In the UK, unemployment dropped by 49,000 a fall of 1.9%. Unemployment now stands at 8.1% in Scotland compared to 7.8% in the UK as the chart below shows

It also worth remembering where we have come from. At peak activity before the Great Recession Scottish unemployment had fallen to 3.9 per cent compared to 5.2 per cent in the UK. While this was a boom period and almost certainly unsustainable it does give a pointer on how far the Scottish labour market has to travel to get back to a more normal or natural rate of unemployment. This is likely to be between 5 per cent and 6 per cent.

Moreover, we cannot say that the rise in Scottish unemployment has been worsened by an increase in labour supply. The chart below shows that the activity rate fell in Scotland in the latest quarter and has been on a downward trend since the start of the Great Recession.

We don't know why this is. It may in part be due to a discouraged worker effect as people leave the labour market frustrated by a lack of job opportunities. This may also link to a rise in outmigration as job opportunities have risen in the UK compared to Scotland.

Unfortunately, the data are not available to provide a detailed understanding of what is currently happening on the supply side of the Scottish labour market. Nor, do we really understand where all the jobs have gone.

Music for Monday: Blackbird - Beatles Cover

Blackbird - guitar playing by me! Recording by Brian Cunningham.

Click the picture. Go on - indulge my fantasy!

The latest FAI Economic Commentary

I am a little late with this: a week in New York escaping just before Sandy hit, then a lot of hard pressured writing to get my contribution into the Commentary and catch-up on postponed family responsibilities, meant no time for blogging.

Things won't get much better this week because I have still got a lot of work to catch up on.

Anyway, the latest Commentary sponsored by PwC is here and my podcast - if you can stomach it! - is here.

We have revised down our forecasts as growth remains weak, with negative growth now expected this year (-0.1%) but positive and stronger growth in 2013 of 1.3%, then 2,2% in 2014. This is slightly better than the median of the latest forecasts for the UK of -0.3%, 1.1% and 1.9%, respectively.

Clearly, any forecast must be viewed sceptically but one reason why we think Scotland might do a little better than the UK is that the data seem to suggest that labour productivity in Scotland has held up better than the UK and may have actually risen.

The following chart shows the change in output and employment in Scotland and UK relative to the pre- (2008-2009) recession peak.

It is quite clear from this chart that labour productivity per worker has fallen in both Scotland and the UK. This is because the drop in output in relation to the pre-recession peak is much greater than the drop in jobs. Moreover, the deterioration in worker productivity appears to be much less in Scotland, with jobs 2 percent and GDP 4.4 percent below the peak. In the UK jobs are almost back to their previous peak, while GDP is nearly 4 percent below.

But look at this next chart.

Total hours worked are more than 6 percent below their pre-recession peak in Scotland while GDP is 4.4 percent below. This suggests that productivity per hour worked must have risen. Yet, in the UK total hours are just 1.4 percent below the peak while GDP is nearly 4 percent below.

We try and offer some explanation for the difference in the Commentary. But we don't really know if it is a measurement issue, or a real difference. If the difference is real, and we have used official statistics, then something has changed in Scotland's labour market compared with the UK. This might mean improved competitiveness here. There again it might not.

Watch this space!