Fraser Economic Commentary - March 2014

Scottish economic growth continues to improve but the recovery could be threatened by imbalances in both the Scottish and UK economies according to our latest Economic Commentary sponsored by PricewaterhouseCoopers LLP. The recovery is being driven by household consumption, activity in the service sector and part-time and self employment. Growth is more likely to be sustained if there is an improvement in investment and net exports, in manufacturing and construction activity and in full-time employment. In addition, an increasingly unbalanced recovery across the regions and nations of the UK does not augur well for future growth.

GDP growth is forecast to be 1.7% in 2013; a further upward revision from our October forecast of 1.3%. For 2014 we have also revised up our forecast from the 1.8% predicted in October to 2.3%, while for 2015, we have revised the forecast up from 2.1% to 2.3%.

The forecasts for 2013 and 2014 are higher than in October because of better than expected outturn data on the growth of household spending, a pick-up in investment, improving trade conditions and increasingly optimistic business surveys. We are now predicting that growth will move above trend next year.

Projected net job creation is 31,450 in 2013, rising to 39,600 in 2014 and 42,800 in 2015. The majority of jobs created continue to be in the service sector. The unemployment forecast has been revised down further again from October, reflecting higher employment given the growth of output.

Unemployment on the ILO measure at the end of 2013 is now projected to be 195,000 (7.1%). By the end of 2014 unemployment is now forecast to be 179,900 (6.6%) falling further to 170,214 (6.3%) by the end of 2015 as growth in the economy strengthens.

Other Key Points

GDP Performance

Positive growth has now been recorded for the Scottish economy in the last 6 quarters.
In the third quarter, GDP in Scotland was -0.9% below the pre-recession peak, whereas UK GDP stood at -1.9% below its pre-recession peak more than 5 years ago. But during 2013, the UK recovery has again been stronger in each of the three quarters of published data so far.
When oil and gas production is removed UK GDP - ex oil & gas - has a much stronger recovery from recession than Scottish GDP. Scottish GDP has recovered by 4.9% since the trough of recession while UK GDP - ex oil & gas - has recovered by 6.8% from its trough.
At the industry level, Scottish services' growth is underperforming the overall performance of the economy in the recovery whereas that is not the case in the UK where the recovery in services has been somewhat quicker.
It is the production sector that has boosted Scottish growth, growing by nearly 10% in the recovery while it has been a significant drag on the recovery in the UK with zero growth since the trough of the recession, which is partly a consequence of the weakness of oil & gas production on the UK production and GDP figures.
It is the performance of manufacturing that is the main driver of the differential performance in production between Scotland and the UK. Scottish manufacturing GVA continues to stand at -4.6% below the 2009-09 pre-recession peak, while the figure for UK manufacturing has dropped slightly to -9% from -9.8% in the second quarter. The favourable gap between Scotland and UK manufacturing performance during the recovery therefore continues to be large.
In Scottish construction while growth in the sector has picked up since the heavy recession period of 2010q4 to 2012q1 performance appears to have weakened relative to the UK from the start of last year. The sector is still very much depressed in both the UK and Scotland. However, the recent stronger performance of UK construction is evident with GVA in the sector standing in the third quarter at -10.9% below its pre-recession peak compared to -13.6% in Scotland.
Business and financial services continue to contribute positively to the growth of the Scottish economy. By the latest quarter, the sector in the UK had moved to +1.3% above its pre-recession peak from -0.4% in the previous quarter, while its Scottish counterpart moved further ahead to stand at 2.2% above its pre-recession peak.
Financial services, however, have contracted since the start of recession but have enjoyed a sustained recovery since the fourth quarter 2012. Some of this lost output may never return. This could still be the case despite the recent recovery in financial services. Moreover, with the recent RBS announcement that significant further cut backs in activity and jobs losses in the bank are to be expected the recent recovery in the sector may fail to be sustained.

Labour Market

The latest labour market data provide further welcome evidence of an improvement in conditions in the Scottish labour market.
The unemployment rate now stands at 7.1% compared to 7.2% in the UK.
Scottish jobs are now -0.2% below their pre-recession peak, which continues to be worse than the UK, where the jobs total is 1.4% above the pre-recession peak. The greater gap between the UK's GDP and jobs position in relation to pre-recession peak compared to the position in Scotland suggests that productivity has fallen relatively more in the UK.
But, the weak labour productivity position in both Scotland and UK is underlined by evidence which shows that increasing numbers of workers are taking part time employment in the absence of full time work.
The employment 'recovery' continues to be driven by an increase in part time work and self-employment, although this may now be starting to moderate.

Policy Recommendations

The Institute believes that there is no substantive reason why Government should accept this weak investment profile.
In addition to increased UK government spending on capital investment, we contend that there is a strong argument for the Chancellor to introduce a programme of private sector investment incentives, such as accelerated depreciation, in his forthcoming Budget.
Moreover, rising regional inequality in growth and income per head in the UK may threaten the recovery, which suggests that there should be differential regional investment incentives as well.
In addition, the Scottish Government should consider raising the funding for its Regional Selective Assistance (RSA) programme and other investment funds administered by Scottish Enterprise.
Of course adopting such incentives is a bit of a policy minefield because of the EU State Aid rules. However, the EU's General Block Exemption Regulation (GBER) allows for regional incentive programmes under certain criteria.
Furthermore, academic evidence on the impact of regional policy in the 1960s shows that it works best when the national economy is expanding or recovering and firms are thinking about investing. So now would is the right time.