Scottish Economy Watch

Independence Fact No. 4

Scotland's exports to rest of UK account for 70% of its exports. Rest of UK exports to Scotland account for 11% of its exports.

 

Memo

• In 2012, Scottish exports to rest UK amounted to £48bn while rest of UK exports to Scotland were £59bn.
• The USA is Scotland's next important export market but is around 12 times less important than rest of UK.
• Estimate rest of UK exports to be £531bn: £493 UK exports plus £59 billion to Scotland minus £21bn exports from Scotland to rest of world.

Evidence

• Scottish Global Connections Survey 2011
• Scottish National Accounts Project
• Office for National Statistics, Balance of Payments Q2 2013

Independence Fact No. 3

Growth in small countries is neither more or less fast than in other countries but is more volatile.

 

Memo

• Small country growth benefits from greater openness to trade.
• Small country growth suffers from loss of scale: border effects (more trade within than between borders); technology (generation and adoption of new technologies may be harder); spillovers (greater within than between countries).
• Paradox between evidence of small country: higher income, higher productivity and evidence of small country: no growth differential and loss of scale benefits.
• Small country annual growth rates are more volatile, partly because of their greater volatility in responses to terms-of-trade shocks.

Evidence

Small states, small problems? William Easterly ([email protected]) and Aart Kraay ([email protected]) No 2139, Policy Research Working Paper Series from The World Bank.

Trade, Growth and the Size of Countries, Alberto Alesina, Enrico Spolaore, Romain Wacziarg.

Is there a large-country advantage in high-tech? Jan Fagerberg

 

Independence Fact No. 2

Small states have higher per capita GDP (are richer) than other states.

 

Memo

• This reflects a productivity advantage
• No certainty that a region of a country that becomes independent will enjoy higher productivity as a consequence: evidence may be due to small regions with higher productivity choosing to be independent while lower productivity regions may choose to be linked to bigger state.
• But there are mechanisms that could raise productivity in new small independent states: attraction of head office functions; better governance (?)

Evidence

Small states, small problems? William Easterly ([email protected]) and Aart Kraay ([email protected]) No 2139, Policy Research Working Paper Series from The World Bank

Large Markets, Gains from Trade, and a Puzzle, David Comerford, July 7, 2013,

Independence Fact No.1

Trade flows, migration flows and capital flows are significantly lower across international borders than within a country.

Memo:

• This holds even if the countries are in a monetary union, single market or free trade area.
• This holds after adjustments are made for size of region/country, proximity, language and culture
• In 2010, 67% of Scottish exports were to the rest of the UK - see here.

Evidence:

National borders matter: Canada-US regional trade patterns, McCallum (1995). Intra-national versus International trade. How stubborn are nations in Global Integration, Wei (1996). National Borders and International Trade: Evidence from the European Union, Nitsch (2000). Intranational Home Bias in Trade, Wolf (2000). Gravity with Gravitas: A solution to the Border Puzzle, Anderson and van Wincoop (2003). The border effects in Spain, an industry-level analysis, Requena and Llano (2006). Is the International Border Effect Larger than the Domestic Border Effect? Evidence from U.S. Trade, Coughlin and Novy (2012). Is the EU internal market suffering from an integration deficit? Estimating the 'home-bias effect', Pacchioli (2011). Gravity Equations: Workhorse, Toolkit and Cookbook, Head and Mayer (2013

Is the recovery starting to falter?

Yesterday the Governor of the Bank of England Mark Carney asserted that Britain's economic recovery was "finally taking hold". And we, that is the Fraser of Allander Institute, said much the same thing for Scotland in our Economic Commentary published two weeks ago. However, we also warned that since the recovery was being principally driven by household spending fuelled by credit that this was likely to be unsustainable given the already high levels of household debt and falling real wages and incomes.

Today we hear that UK retail sales fell in October and remained broadly flat over the past three months. This followed fairly strong sales growth in the three months to September, with UK retail sales volumes growing by 1.6% in the quarter and Scottish retail sales growth a little weaker at 1.1%.

Of course this might just be a one month blip and the growth of retail sales and domestic demand could well pick up again, boosted perhaps by positive contributions from net trade. But in Scotland there are signs from the latest official statistics of some slowing in domestic demand to the second quarter of this year.

Yesterday, the Scottish Government published Quarterly National Accounts from the Scottish National Accounts (SNAP) project. These data are still considered to be "experimental" but to my mind they are very valuable nonetheless.

Using these data we can compute the contribution of the major expenditure components to nominal - includes price change as well as volume change - GDP growth in Scotland. I have done this first for the year - four quarter on 4 quarter - to the second quarter and the results are in the following chart:

These data show that with nominal GDP growth of 1.8% over the year by far the most important driver of growth was household spending. There was also a small positive contribution from Government but net trade and investment made a resoundingly negative contribution.

However, if we just look at the second quarter of this year we get the next chart:

With nominal GDP growth of 1.3% in the quarter, by far and away the main driver of growth was net trade as Scotland's large trade deficit reduced a little due to growth in the value of exports of 1.3%, while the value of imports (including account balancing items) fell by 0.3%. Domestic household spending was actually flat. However, the spending of non profit institutions serving households and non-resident household spending made the overall household contribution slightly positive. But note the contribution to growth was less than government spending.

It might be reasonable to respond to this by pointing out the now positive contribution of net trade. Maybe this does indicate that the long awaited re-balancing of the economy away from domestic consumption to external demand and investment is occurring.

But wait!

Today's news also revealed that eurozone growth was much weaker than expected in the third quarter with the FT reporting that

The weak performance in France will cause particular concern over the durability of a broader eurozone recovery.....

With growth almost flat and inflation verging on deflation it is clear why the ECB cut its rate by 25 basis points last week.

We are not out of the woods yet.

Still a lot of slack in Scottish labour market

A reminder that there is still a lot of slack - people likely to work if job prospects improve - is illustrated by the following chart:

Jobs are being created in greater numbers. But the population is growing, so we need more jobs just to maintain the same employment rate: running to stand still. This is why statements heard on the lunchtime news that "the number of jobs in the economy are at their highest ever" are, quite frankly, ludicrous. Update: while for the UK this may be formally correct, it does not tell us very much about the state of the labour market, because it is bigger due to an increase in supply (population).

Scottish Job numbers: almost back to 2008

The latest Scottish labour market data continue to offer encouragement. However, not everything is rosy in the Scottish labour market.

First, the good news. Scottish employment is almost back to where it was in 2008 at its pre-recession peak. The chart below illustrates.

Jobs are currently-0.2% below the 2008 peak. So after more than 5 years we are almost back to where we were in terms of the number of jobs. The UK is still doing slightly better, having already attained its pre-recession peak, but with 75,000 jobs created in Scotland over the past year, jobs growth was faster than anywhere else in the UK except the South East of England as the chart below shows.

The less good news is that this strong jobs growth has not produced much of a boost to full-time employment; the next chart illustrates:

Over the year to July-June 2013 full time employment was 134,000, or -7%, lower than the 2008 pre-recession peak. (Note that this is annual average data to June so does not fully reflect where the economy is likely to have been in September.)

So, it appears that the growth in jobs is still heavily biased in favour of part-time employment, whether self-employed or employees.

The bad news is that unemployment in Scotland rose by 1,000, while UK unemployment fell. But there is a positive dimension to this, since the numbers inactive fell by 7,000 in the quarter and by 31,000 over the year. This suggests that the better prospect of a job is attracting people, and women in particular, back into the labour market. Secondly, the Scottish unemployment rate remains the same as the previous quarter and below the UK as the next chart indicates.

With UK unemployment falling by 48,000 in the quarter the unemployment rate fell from 7.8% to 7.6%. The lower UK unemployment rate is stimulating market interest in the prospect of a UK interest rate rise in 2014 if, as is now likely, the rate falls to 7%. Readers will remember that this is the rate below which the new Governor of the Bank of England, Mark Carney, in his forward guidance suggested the Bank's MLR could rise.

Of course, there is no guarantee that rates will begin to rise as soon as 7% UK unemployment is reached, it will also depend on what is happening to inflation and core inflation, largely wages, in particular. The latest UK labour market data show the growth in earnings averaging only 0.7% over the three months to September, with earnings in the private sector rising by 1.1% over the same period.

Even with the growth in consumer prices slowing to 2.2% - a 13 month low - in the year to October, down from 2.7% in September, this still suggests that real wages are continuing to fall. In these circumstances, the prospect of a sustained recovery driven by household spending is unlikely. Moreover, the froth in the financial markets at the prospect of higher UK rates has pushed sterling higher and then lower as the inflation data came in and now higher following the latest unemployment figures.

A high and volatile sterling rate will not help UK exports or the recovery.

The Governor should be more explicit in his forward guidance if the policy is not to damage rather than assist the UK recovery. He should explicitly adopt Paul Krugman's recent advice to the US Federal Reserve:

The lesson you should be taking here is, don't tighten, don't taper, don't exit, until you see the whites of inflation's eyes.