Scottish Economy Watch

The Budget – an essay in economic illiteracy?

Step back from the detail of Chancellor George Osborne’s Budget today and ask yourself: Does this Budget help the economy to move to a sustained recovery?

Remember we have an economy which is largely recovering on the back of household demand, which is built on shaky foundations: a falling savings ratio, higher borrowing when household debt is still exceptionally high in historical terms and real incomes that continue to fall. Investment is beginning to recover but is exceptionally weak. Net trade too is even weaker in the UK, a little stronger in Scotland.

So what has the chancellor done to ensure a more balanced and sustainable recovery?

On the positive side he has doubled and extended the Annual Investment Allowance estimated to cost £2 billion, which is a significant measure. This should help investment and mirrors what we argued for in the latest Economic Commentary last week. There are measures to help cut production costs such as the £7 billion package to reduce energy costs. These should help competitiveness and may improve export performance and so boost net exports.

But what was the centre piece or show piece measure introduced in this Budget?

A major boost to savings!

Yes, significant measures on ISAs, pension annuities and so on designed to encourage savings. Now think about the economics here: a rise in savings means lower household spending and therefore a reduction in demand in the economy. This at the same time as the Chancellor feels the need to continue his austerity programme further driving demand from the economy.

We do need measures to boost productivity, to improve the supply side. But in the here-and-now it is still demand that is key.

The Chancellor’s economics beggars belief.

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.

A Fiscal Dividend: UK Union or Scottish Independence?

The publication today of Government Expenditure and Revenue Scotland 2014 (GERS) provides information on Scotland's fiscal position in 2012-13 with revisions for earlier years. The document is obviously important since it is the last one in the series before the independence referendum on 18 September.

What is the prospective voter in the referendum to make of the figures contained in it?

Danny Alexander, Chief Secretary to the UK Treasury states:

The Scottish government's argument for independence has been undermined by their own figures. It shows that in 2012-13, the Scottish deficit per person was almost £500 worse than that of the UK.

While Alex Salmond, First Minister of Scotland argues:

Today's Gers report confirms what independent commentators and analysts have been making clear - Scotland is one of the wealthiest countries in the world. The figures show that tax revenues generated in 2012-13 were £800 higher per head in Scotland compared with the UK, meaning that now for every one of the last 33 years, tax receipts have been higher in Scotland than the UK

So who is correct?

Well, in a sense, they both are!

The problem is that these statements do not really give much of a guide about the fiscal position in an independent Scotland compared to the position within the UK union. This is of course a complete unknown because economic conditions and policies will be likely to be different in both a future UK union and a future independent Scotland.

However, what might be of help is to conduct a form of thought experiment. In this experiment we can ask has Scotland over the past five years enjoyed a fiscal dividend in the UK union or has it suffered a fiscal cost compared to independence?

Clearly, such an analysis cannot change policies or economic conditions but I still think it is an illuminating exercise none the less.

We know from GERS what Total Managed Expenditure (TME) has been in Scotland over the last five years. We also know the GERS estimate of total tax revenue. We can proxy tax revenues under independence by adding in a geographical share of North Sea oil revenues. We can proxy public spending under independence by taking a Scottish population share of UK TME, so that the Scottish people are no worse off in terms of public services than their rUK counterparts.

That done, we can then compare with the estimated spending and revenues in GERS published today, which is what the table below shows:

	(£ million)
Fiscal   Year	2008-09	2009-10	2010-11	2011-12	2012-13
Spending
Total   Managed Expenditure for Scotland	59,440	62,087	64,095	64,869	65,205
Scots per capita share of UK   TME	53,393	55,219	56,271	56,934	57,538
Excess spending	6,047	6,868	7,824	7,935	7,667
Tax Revenues
With Geographical share of oil revenues	55,349	47,733	51,773	56,315	53,147
Scots tax revs plus Per   capita share of oil revenues	44,820	42,557	45,023	47,264	48,118
Excess revenues	10,529	5,176	6,750	9,051	5,029

 

Excess spending shows the gain to the Scottish people in the UK union - loss under independence - of the spend on public services compared to the rest of the UK, which is the assumed counterfactual minimum that would be expected under independence.

Excess revenues shows the gain in tax revenue under independence - loss under the UK union.

The figure below charts the two and the figure after that the difference between the two:

So there is a fiscal dividend from independence in two of the five years and a fiscal dividend from the UK union in three of the five years. Taking the five years together there is a net dividend in favour of independence of £193 million. This amounts to 0.3% of average TME in Scotland over the five years, or £39 per person or roughly £8 per year.

The following points can be made:

• The fiscal dividend to independence can therefore be considered to be very small and appears likely to be negative in the near future.

• There is no estimate of the economic and fiscal transition costs of Scotland becoming an independent state, which if included would additionally make the dividend negative.
• In the fiscal year 2008-09 oil prices and oil revenues were high. In the future, oil revenues are likely to decline as the volume of production falls considerably from the position in 2008-09.
• During the last five years the Scottish people have had returned to them in higher public spending almost all of the oil tax revenues that went to the UK Treasury.
• We cannot determine the fiscal position of an independent Scotland in the long-term because different economic conditions and policies in both rUK and Scotland will determine whether there is a fiscal dividend, or a fiscal cost to independence.