Scottish Economy Watch

Financial hotspots

Today the Herald contains a piece drawing on a report compiled by commercial think-tank Z/Yen - a tank of thinkers that has not crossed my doorstep before. The report according to the Herald reveals that:

GLASGOW has overtaken Edinburgh as Scotland's most important financial centre in the latest ranking of the world's economic hotspots. The biannual Global Financial Centres Index shows that Glasgow dropped 11 places to 50, but was still ahead of Madrid, Beijing and Bangkok. However, the Scottish capital slumped even further, down 17 spots to 54 in the list, a reflection of the turmoil that has swept through the Scottish banking centre in recent years

No information is given as the importance of each financial centre is measured and the criteria against which each are ranked, the source of the information and how statistically robust the data are.

There is no doubt that perceptions are important. But one test of the importance of a financial centre is the size of its contribution to output or value added and perhaps jobs. Value added does capture quality but the number of jobs less so.

The ONS produces sub-regional gross value added (GVA) data. In the latest release in December, the scale of finance and insurance activities in Glasgow and Edinburgh is readily identifiable. The chart below reveals the situation in 2010

That makes Edinburgh financial services more than 254% (2.5 times) larger than the GVA produced in the sector in Glasgow.

In jobs terms, financial and professional services employed 50,500 in Edinburgh and 37,500 in Glasgow.

Now clearly, these data are a little out of date but I find it difficult to believe that output and jobs have changed so rapidly in the last 18 months or two years to reverse the position in Glasgow relative to Edinburgh.

Neither city should be complacent in terms of perceptions of their international standing in financial services. And clearly, if perceptions turn against Edinburgh and Glasgow so that business is lost then value added and jobs will eventually fall.

But we should beware the declarations of commercial think tanks that do not publish the detailed data underpinnings of their so-called findings.

As Pa Entwhistle, and some say 'Oor Wullie's grandpa, used to say:

"Daft I call it!"

Whither full-time employment?

The latest labour market data for Scotland allow us to update the analysis of the composition or type of employment change.

The updated chart to Oct 2011-Sept 2012 is shown below

While these data lag the latest total jobs and unemployment data to Nov-Jan 2013, they offer a pretty stark reminder of the significant change in composition that lies beneath the overall employment numbers.

Full-time employment has been the main casualty falling by -7.2% from its pre-recession peak. Part-time and self-employment, in contrast, are +8.7% and +11.3%, respectively above their pre-recession heights.

While there are clearly structural changes occurring in the labour market on the demand side, with more workers expressing a preference for part-time and self-employment, the bulk of the change is largely driven by supply-side rather than demand side change. Put more simply this means that the switch is more a reflection of the wishes of firms hiring workers than the choice of workers themselves - see the STUC here.

I suspect we can only be certain of a sustained recovery in the Scottish labour market when the number of full-time employees begins progressively to rise.

Recovery or false dawn in Scottish jobs market?

Last week the latest Scottish jobs and unemployment data were published and somewhat lost amidst the media coverage of the Budget.

These labour market numbers were clearly better than they have been for some time. During the quarter to Nov-Jan 2013 employment rose by 19,000, unemployment fell by 4,000 and the numbers inactive also fell, by 11,000. The 16 plus activity rate rose slightly from 62.3% to 62.6%, the unemployment rate fell from 7.6% to 7.4%, and the inactivity rate fell from 37.7% to 37.4%.

All good news.

Moreover, given the fall in the numbers inactive my estimate of 'real' unemployment also dropped relative to the measured number and rate of unemployment - see chart

Clearly, one swallow doesn't make a summer.

The estimate of real unemployment is still 63,000 higher than the ILO unemployment measure for Scotland; that is 2.2% points higher than the official rate of 7.4%.

The jobs numbers also continue to look weak when compared to the pre-recession figures as this chart shows

After nearly 5 years employment remains 68,000 below the pre-recession peak, a short-fall of -2.7%.

Added to this, with the working population rising, the ratio of employment to working population still looks like an economy in recession:

One would like to hope that we are beginning to see the start of a more sustained recovery in the labour market in Scotland. But several more quarters of positive data are required before we can conclude that hope has finally triumphed over experience.

Where have all the new firms gone?

 Personal note: For anyone who might have noticed I haven't blogged much in the last month. This has been largely due to a vicious viral infection, which has laid me low for the past few weeks. I am now back at my desk, if still slightly groggy. Hopefully, I can start to produce more blogs but probably not until after a week away on Mull next week!

While in my bed, new business statistics from the Committee of Scottish Clearing Bankers were published for the fourth quarter 2012. As I noted in earlier posts e.g. here, this series records new business start-ups based in Scotland that have opened accounts with any of the four Scottish Clearing Banks. It is a valuable series because it should be expected that the creation of new firms would move in line with overall economic performance and GDP in particular.

The latest data show a drop again in new business formation between the third and fourth quarters with the number of new starts falling by 375 from 3,091to 2716. But as explained before the CSCB data are not seasonally adjusted, so I have constructed a four-quarter moving average, which smoothes out some of the seasonality and other short-term fluctuations. The updated chart is here

At a time when there is much concern about both lack of demand and weakness in the supply capacity of the UK and Scottish economies, these data are a clear cause for concern.

In the latest data, the number of starts is 47 percent below the (smoothed) pre-recession peak compared to 45 percent in the third quarter. Alternatively, the latest numbers are 35 percent below the average quarterly starts in the period before the recession started, compared to 33 percent in the third quarter.

It is possible that Scottish new starts are creating bank accounts with non-Scottish Clearing Bankers. But that seems unlikely.

It is more likely that the data reflect:

• a continuing lack of demand for goods and services which is discouraging new starts;
• the failure of the banks to lend to new starts because of increased risk aversion on the part of the Scottish banks compared to the period before the recession.

An examination of the industrial pattern of new starts offers more information Between 2011 and 2012 the number of new businesses fell by 881 from 14,737 to 13,856. The industrial distribution of that change between 2011 and 2012 is shown in the chart below.

The chart makes clear that the weakest sectors in terms of new business creation were in property related activities and business services, construction, wholesale and retail activities, and in other financial intermediation. In some ways that maps what has been happening to output across the Scottish economy.

In contrast, it is good to see a pick-up in manufacturing new starts, which again reflects what has been happening to output. There would also appear to be some growth in small businesses serving the public sector and insurance and pensions sectors, which may reflect the evidence of a shift away from full-time employment to self-employment.

Overall, the new business data appear to confirm a picture of an economy still suffering from a lack of demand with a hangover from the property and finance boom and bust that preceded the loss of output and jobs in the Great Recession.

It's not just size that matters.

The spin and hype from the 'yes' and 'no' campaigns after the publication of the Government Expenditure and Revenues Scotland (GERS) was enough to make the eyes water.

In 2011-12 the estimated net fiscal balance (with a geographical share of oil) is -5% of GDP compared to the UK's balance that year of -7.9%.

The 'yes' campaign and supporters of independence argue that GERS demonstrates that Scotland's fiscal position is better than the UK. The 'no' advocates highlight the importance of north-sea oil revenues amounting to £10bn, or 17%, of estimated current revenue. North-sea revenues are volatile and projected by the OBR and others to be in long-term decline. The size of Scotland's net deficit is likely to worsen both absolutely and relative to the UK.

In a sense both sides of the campaign are correct, although for the Scottish Finance Secretary John Swinney to say that the figures showed that Scotland was better off to the tune of £824 per person is stretching it a bit. We didn't have a bigger surplus but a smaller deficit, courtesy of oil revenues, of £7.6bn, or 5%.

The 'no' campaign also need to be reminded that there will be policy options open to an independent Scottish government to help reduce spending, raise taxes and lower the deficit e.g. less defence spending, policies to stimulate migration that will mitigate Scotland's developing demographic problem etc. GERS offers a static picture with the finances likely to evolve after independence.

Yet, a deficit will still have to be funded. And what is important is not just the size of the deficit but the cost of funding it i.e. the cost of borrowing.

As I noted in this detailed post a newly independent Scotland is likely to have higher borrowing costs than the UK for three reasons.

First, a recently independent Scottish government, with no previous experience of and reputation for fiscal management will have a credibility problem. 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. According to OECD evidence small countries tend to pay a risk premium on their borrowing simply because of their size. Moreover, 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.

So, we cannot simply judge the health of an independent Scotland's public finances by the scale of its likely deficit, the cost of borrowing is as important.

It's not just size that matters.

 

Latest FAI Economic Commentary

The latest Fraser of Allander Institute Economic Commentary, sponsored by PricewaterhouseCoopers LLP is available here.

There is much in the Commentary including signed pieces by researchers outside the Commentary team e.g. Iain Inglis, and Kenny Richmond from Scottish Enterprise on The technology company development journey – from concept to commercialisation, and David N.F. Bell, University of Stirling Alasdair G. Rutherford, University of Stirling,Robert E. Wright University of Strathclyde on Free Personal Care for Older People: A Wider Perspective on Its Costs.

A brief summary of the Outlook and Appraisal and forecasts follows:

The Institute notes that there was evidence of some genuine growth in the Scottish economy in the third quarter of last year. Also the new GDP methodology and revisions have meant the fit with the UK economy during recession and recovery is closer. The recovery has been a little stronger than the earlier data suggested but still a little weaker than the UK as a whole. But survey evidence suggests a weakening in the final quarter of 2012 and uncertain prospects for 2013.

It is quite clear the main components of aggregate demand in the Scottish economy remain weak.

Household demand growth is weak, due to

• Falling real incomes as inflation above earnings growth of 2%.
• Employment is falling again and number of hours worked is very low.
• The housing market is flat with no growth in house prices offering no boost to household wealth and increased spending.
• The Scottish household saving rate is high and rising; at 11.1% it is 3.4 percentage points higher than in the UK.

Investment spending is falling both absolutely and relative to GDP - see chart below drawing on latest (28 February publication) Scottish National Accounts Project (SNAP) data

After improving during the recession our relative export performance has deteriorated since 2011 with negative contribution to growth - see next chart drawing on SNAP data

The prospects for a growth in the contribution of net trade depend in the short term:

• On the recovery of demand and output in the eurozone from the current recession and wider growth of world trade.
• Huge uncertainties exist over eurozone prospects.
• The main beacon of hope is recovery in the US economy but this is not without its uncertainties.
• But also price issues as well as demand:
  • The effect of sterling devaluation
  • The intrinsic competitiveness of Scottish companies – more significant for long-term growth

Government fiscal consolidation is set to increase as the UK Government strives to meets its target of balance in its structural (cyclically adjusted) current budget in five years. Most of the future adjustments concern spending rather than taxation with 68% of planned benefit cuts and 78% of current departmental spending cuts still to come after April this year. These cuts will depress household demand as well as reducing government spending directly.

The labour market in Scotland shows falling measured unemployment but from the middle of last year employment is falling and the number inactive continues to rise. The 'real' level of unemployment is clearly higher and that will contribute to weak household spending on goods and services.

Other Issues

• Quite clear that austerity has reduced growth.
• Weak UK export performance is also a factor in a failure to recover strongly.
• Lack of bank lending is still constraining, especially for small businesses.
• Loss of AAA credit rating will make no difference to UK borrowing costs and ability to borrow.
• Little threat from inflation, indeed inflation will be allowed to go higher and sterling lower to help recovery.

Forecasts

• GDP growth is now forecast to be 0.9% in 2013 and 1.7% in 2014, a lowering of the Institute's forecast in November, rising further to 1.9% in 2015.
• Projected net job creation is 9,400 this year, rising to 19,150 in 2014 and 31,800 in 2015.
• Unemployment is now forecast to be 218,300 by the end of 2013 and 228,500 in 2014. By the end of 2015 unemployment is forecast to have fallen back to 204,100 as the economy recovers more strongly.