FAI Economic Commentary - June 2014

 

The Institute's latest Economic Commentary on the Scottish economy, sponsored by PriceWaterhouseCoopers, is published here. 

In summary:

Overview

The Scottish economy is now enjoying a strong recovery. However, the Institute cautions that the recovery is subject to the risks of: a continuing unbalanced recovery; falling real wages; booming house prices in the London housing market, and deflation in the Eurozone. Nevertheless, the Institute has raised its forecasts from March and its latest economic forecasts for Scottish GDP are, for: 2014: 2.5% (up from 2.3%); 2015: 2.2% (down from 2.3%); and for 2016: 2.4%. Net job creation is forecast to continue and strengthen, while unemployment is projected to fall.

Recent Performance

GDP

• The latest Scottish GDP data for Q4 2013 show that Scottish GDP rose by 0.2% in the quarter, significantly less than the 0.7% rise in the UK.
• However, it is clear that the Grangemouth dispute was responsible for reducing GDP by about -0.4% in the Q4 2013, suggesting that the implicit growth of the Scottish economy in the quarter was about 0.6%, close to but a little less than UK GDP growth at 0.7%.
• When oil and gas production is removed, to ensure a like-for-like comparison, the respective Scottish and UK growth rates remain the same for the latest quarter but over the year UK growth rises to 1.8% with Scotland at 1.6%.  The long period of weak oil and gas production has resulted in the UK GDP - ex oil & gas - having a much stronger recovery from recession than Scottish GDP.
• Scottish GDP has recovered by 5.02% since the trough of recession while UK GDP - ex oil & gas - has recovered by 7.41% from its trough. So, by the final quarter of last year UK GDP - ex oil & gas - was -0.5% below its pre-recession peak compared to -0.9% for Scotland.
• Scottish services have now attained their pre-recession peak and stand at 0.3% above c.f. +1.2% in UK.
• Manufacturing GVA contracted in 4^th quarter by -2.2%. Grangemouth dispute played big role here. Now -7.2% below pre-recession peak c.f. UK -8.9%
• Construction still weak here -13.5% below PRP c.f. UK -12.5%.

 Labour Market

• In the quarter February to April 2013, employment rose by 0.6% in Scotland and 1.1% in the UK. In terms of numbers, jobs rose by 16,000 in the quarter, compared to a remarkable rise of 345,000 in the UK as a whole. Over the year, Scottish jobs rose by 48,000, a rise of 1.9%, while UK jobs rose 780,000, or 2.6%.
• During the quarter unemployment in Scotland, in a reflection of the jobs increase, fell by -7,000, or -3.6%, to 183,000, or a rate of 6.6%, while in the UK, unemployment fell more rapidly by -161,000, or -6.9%, to a rate of 6.6%.
• Scottish jobs as reported in the LFS worker surveys have now reached their pre-recession peak, which continues to be worse than the UK, where the jobs total is 2.1% above the pre-recession peak, compared to 0.2% in Scotland in the final quarter of last year.
• However, it is worth noting that the ONS employee jobs series for Scotland shows that there were 2,343,000 employee jobs in Scotland in the final quarter of 2013. This was an increase of 66,000 jobs from the end of 2012, but 137,000 jobs (5.5%) lower than the peak of employee jobs in Scotland in Q3 2008 (2,480,000).
• By January - March 2013 the employment population ratio in Scotland stood at -2.8% below the pre-recession peak. This suggests that there is still plenty of slack in the Scottish labour market. The evidence that the growth in employment is still sustained by the growth of part-time workers and the self-employed provide a further indication of slack in the labour market. Moreover, there are still a large number of part-time workers that cannot find a full-time job.

Risks

The Institute sees that there are four potential risks to a sustained recovery of the Scottish economy:

• a failure to achieve a balanced recovery (as between household consumption, business investment and export growth)
• weak or no growth in real UK wages
  
• an overheated housing market, especially in London and the South East of England and its potential impact on UK interest rates
• the risk of deflation in the Eurozone

 Balance

• The evidence suggests that the UK and Scotland are still a long way off from a balanced recovery.
• Investment does seem to be picking up and it is to be hoped that this will continue, because the prospects of a marked improvement in the net trade position with sterling high and the European economies weak, does not augur well.
• And while household spending is currently strong, its underlying determinants appear weak.

 Real wages

• A key reason for concern about the sustainability of household spending is that debt levels to income remain high and real wages are falling!
• Real wage growth needs to move into positive territory for the prospects of a sustained growth in UK household spending to be certain.
• One critical factor here is whether labour productivity can begin to grow strongly. Without a step-change in the rate of growth of productivity the likelihood is that the recovery - as the economy begins to approach capacity - will see rising nominal wages but little increase in real wages as the growth of product prices matches that of nominal wage growth.
• Yet, data suggest that real Scottish wage growth become positive in 2013 whilst UK growth has remained negative for the past three years. This could be due to a faster growth in labour productivity in Scotland than in the UK, but we have no up-to-date data on labour productivity on this matter. Nevertheless, the recent recovery in UK jobs growth has been faster than in Scotland whereas GDP growth has been more similar suggesting faster productivity growth here.
• So, on this basis, the prospects for Scottish household spending might be a little rosier than in the UK.

 Housing market

• Arguably, the biggest threat to the recovery in both Scotland and the UK comes from the housing market.
• House prices are rising at an annual rate of 8% in the UK but by 17% in London.
• Scotland’s house prices were largely flat over the year to March 2014 with growth of only 0.8%.
• We believe there is a strong case for the Bank of England to exercise its currently limited macro-prudential policy powers through its new Financial Policy Committee by seeking to curb high loan to income ratios. The Bank of England should not seek to raise interest rates largely on this account.
• Rising house prices are essentially a London and South East England phenomenon. In Scotland, house prices are hardly rising overall. So, it would seem inappropriate for the recovery to be dampened right across the UK for what is clearly a local or regional issue centred on London.

 Eurozone deflation

• The final obstacle to recovery is the risk of deflation in the Eurozone, with prices poised to begin falling, the Eurozone risks a decade or more of Japanese-style stagnation. 
• This would lower demand for imports and limit foreign investment and would be very damaging to any export recovery in both Scotland and the rest of the UK.
• ECB has started to loosen monetary policy but more needs to be done

 Forecasts

• We are forecasting growth in Scottish GDP of 2.5% in 2014, 2.2% in 2015, and 2.4% in 2016. This represents a slight increase for 2014 and a slight decrease for 2015 over our March 2014 forecast.
• Production and manufacturing continue to be the major sectors exhibiting the fastest growth in 2014, 2015 and 2016.
• Our forecasts for employee job creation are broadly similar to our March 2014 forecasts, with a slight upward revision for 2014 and small downward adjustment for 2015.
• On the central forecast, we are now forecasting that net jobs will increase by 43,100 in 2014, 42,900 in 2015 and 58,150 in 2016. Our projection for unemployment on the ILO measure at the end of 2014 is now 173,150 (6.4%).
• By the end of 2015, unemployment is now forecast to be 168,150 (6.2%) falling further to 157,200 (5.8%) by the end of 2016 as growth in the economy strengthens over 2015.