Scottish Economy Watch

Scottish economy improving, but recovery uncertain

Scottish economic growth continues to improve but doubts remain about a sustained recovery according to the latest Economic Commentary from the University of Strathclyde's Fraser of Allander Institute, sponsored by PricewaterhouseCoopers LLP. The improvement in growth is mainly dependent on growth in household spending. As a result, we have raised our forecasts for growth in 2013, from 0.9% to 1.3%, and in 2014, from 1.6% to 1.8%. Growth in 2015 is predicted to be 2.1%, roughly at trend.

However, we note that the main drivers of household spending remain weak. Spending is being supported by increased borrowing and reliance by some households on the growth of pawnbrokers, cash generators and pay-day loan operations on Scottish high streets. This combination provides an unlikely basis for a sustained recovery. A continued improvement in net exports and in physical investment spending would appear necessary for a durable recovery, particularly with the UK Government's programme of fiscal consolidation set to continue.

Key Points

GDP Performance

• The Scottish economy has grown for five successive quarters to the second quarter of this year. The UK has grown for three successive quarters to the third quarter of the year. And the growth rate has been rising as 2013 unfolds.
• The industry structure of the recovery differs between the UK and Scotland.
• The service sector is weaker in Scotland while growth in production and the manufacturing sector within it has been stronger in Scotland. However, construction sector growth has been quite similar between the two countries with recovery weak.
• Financial services appear to have experienced a structural decline since the beginning of the recession in both Scotland and the UK. This decline may be bottoming out but whether the sector will return to 2007 levels of output is a moot point.
• It is clear that a strong recovery is now taking place in the important business services sector in Scotland and the recovery is stronger than in the UK. The recovery and growth of real estate activities and transport, storage & communications in Scotland is weaker, while that in distribution is stronger.

Labour Market  

• Despite recent strong job creation, Scottish jobs are now 0.8% below their pre-recession peak, which is worse than the UK, where the jobs total is 0.8% above the pre-recession peak.
• But Scotland's unemployment rate of 7.3% is lower than the UK's 7.7%.
• The employment population ratio is at -3% below pre-recession peak suggesting that there is still much spare capacity and labour reserves in the Scottish economy.
• Labour productivity in Scotland has improved relative to the UK, which has experienced a sharp drop in productivity.
• With a recovery in output and jobs now clearly occurring, the key question is whether it can be sustained over several quarters and even years.

Will the recovery be sustained?

• The improvement in growth is mainly dependent on growth in household spending. Investment continues to decline and net trade is erratic, although there was a positive contribution to growth in the first quarter.
• Yet, the main drivers of household spending remain weak: real wages are falling as pay fails to keep up with the rate of inflation; asset prices remain flat, especially housing in Scotland; share prices are rising but contribute little to spending ion Scotland due to low share ownership.
• So, what spending growth there is is being supported by increased borrowing.
• There appears also to be reliance by some households on the growth of pawnbrokers, cash generators and pay-day loan operations on Scottish high streets. This combination provides an unlikely basis for a sustained recovery.
• A continued improvement in net exports and in physical investment spending would appear necessary for a durable recovery, particularly with the UK Government's programme of fiscal consolidation set to continue.

Forecasts

• GDP growth is forecast to be 1.3% in 2013; an upward revision from our June and March forecast of 0.9%.
• For 2014 we have also revised up our forecast from the 1.6% predicted in June to 1.8%, while for 2015, we retain the same 2.1% prediction as in June.
• The forecasts for 2013 and 2014 are higher than in June because of better than expected outturn data on the growth of household spending and increasingly optimistic business surveys.
• However, we are still predicting below trend growth next year reflecting the continued relative weakness of domestic demand, in particular government spending and consumer expenditure, and only slowly rising growth in eurozone markets but stronger growth in the rest of UK.
• Projected net job creation is 21,200 in 2013, rising to 27,200 in 2014 and 38,400 in 2015. The majority of jobs created will be in the service sector. The unemployment forecast has been revised down again from June, reflecting higher employment given the growth of output. We are now seeing many workers re-entering the labour market as job prospects improve.
• The upshot is that unemployment may not fall as much as the job creation figures might suggest.
• Unemployment on the ILO measure at the end of 2013 is now projected to be 204,550 (7.6%). The unemployment position is again expected to deteriorate slightly in 2014 compared to 2013 due to relatively weak output and employment growth. Unemployment is now forecast to be 224,800 (8.4%) by the end of 2014 but then falls back to 186,450 (7.0%) by the end of 2015 as growth in the economy strengthens.

Losing Grangemouth

There is no doubt that the announcement by Ineos early today of the closure of its petrochemicals plant at Grangemouth and the possible closure of the adjacent refinery is a major blow to the Scottish and even the UK economy.

As the day drew on the scale of the closure and its wider implications began to be appreciated: some 1370 direct jobs on the site, with 800 in the petrochemicals plant and 570 in the refinery; maybe up to 2,000 sub-contractor jobs; suggestions that around 10,000 jobs in the Scottish economy as a whole - about 0.4% of employment; refined petrol and chemicals account for nearly a quarter of Scottish manufactured goods sold to the rest of the world, the loss of Grangemouth would remove most of those exports.

Some commentators saw the actual and potential closure as equalling the harmful effect on the Scottish economy of the loss of a sizable portion of the electronics industry in Scotland in the early 2000's. Others saw it as comparable to the loss of the Ravenscraig steelmaking plant in the early 1990s.

So can we stress test some of these claims? Is there a scientific or quasi-scientific way of addressing the issue?

The answer is yes!

We have the Scottish Input-Output tables which have for many years been produced by the Scottish government. Using the latest tables for 2009 and some inevitable guesstimates I have computed the following estimates of the likely impact of closure on GDP/GVA, jobs and employee income in the Scottish economy:

The monetary values and ratios to GDP and employee income are in 2009 prices, while jobs and jobs share relate to current 2013 figures.

The I-O tables have a sector 27 which comprises coke, petroleum and petrochemicals. I have assumed that Grangemouth accounts 75% of the value of output in this sector. That is the main assumption. I have also assumed that GVA is divided between the refinery and the petrochemicals plant in the same proportion as employment. This could clearly be erroneous but I hope not by much!

We can now apply the multipliers for the sector to the anticipated GVA, jobs and employee income losses for the petrochemical plant, the refinery and the whole site.

The results of this exercise suggest that closure of the petrochemicals plant will have an economy wide impact of 0.7% of GDP, 4,240 jobs - 0.2% of total employment - and 0.3% of employee income. For the refinery, the comparable numbers are 0.5% of GDP, 3,021 jobs - 0.1% of employment - and 0.2% of employee income.

Closure of the whole site would lead to a 1.2% fall in Scottish GDP, the loss of 7,261 jobs - 0.3% of employment - and a loss of 0.5% of employee income. This is a sizable impact if less than some of the more wild predictions heard earlier today.

Even if the whole site closes the loss to Scottish GDP will be less than the loss to Scottish GDP from the collapse of electronics which led to a 2.5% direct reduction in GDP as its weight fell from 4.6% of GDP in 2000 to 2.1% in 2004 and about 1% today. These figures exclude any knock on or multiplier impact on other industries.

But the impact of the closure of Grangemouth would be similar to the closure of Ravenscraig. When Ravenscraig closed we at the Fraser of Allander Institute estimated that from 1220 direct job losses at Ravenscraig and the Hunterston ore terminal, the wider impact would be 5580 jobs between 1992 and 1996. Our estimate of the impact of the loss of steel production on Scottish GDP was less than 0.5%.

The two closures are clearly comparable.

But that will be of little comfort to the vast number of workers in Scotland whose jobs are now at risk.