Fraser of Allander Economic Commentary – 12 November 2014

 

Overview

• In the latest Economic Commentary we note that in the first half of the year the Scottish economy delivered strong economic growth, increased job creation and falling unemployment.

• However, there are signs that growth may be beginning to slow. Growth in the wider global economy and the UK economy appears also to have begun to slow recently.

• There are fears that the global economy faces a situation of secular stagnation, a permanent deficiency of demand, which can’t be overcome even with near-zero interest rates.

• The recent indicators of slowing demand both at home and abroad, falling real wages, rising levels of household debt, the prospect of more substantial UK fiscal austerity to come, and the deeper concerns about secular stagnation raise several questions.

• Questions that can be posed but cannot be definitively answered, such as whether the Scottish and UK economies are now poised for a period of slower but sustainable growth, or whether growth will slow and then slip back into recession? Are we at a turning point or are we on a knife-edge?

Output

• The latest Scottish GDP data for Q2 2014 show that Scottish GDP rose by 0.9% in the quarter, much the same as in the UK.

• Over the year to the fourth quarter - four quarters on the previous four quarters - Scottish GDP grew at 2.4%, a growth rate that is above trend.

• In the second quarter, GDP in Scotland was +1.1% above its pre-recession peak. Because of changes to accounting practices in the UK, which have yet to be introduced in Scotland, we do not have comparable UK data to Scotland in the second quarter. So, up to the first quarter of the year UK GDP was still -0.6% below its pre-recession peak compared to +0.2% in Scotland.

• The overall strength of the recovery has, nevertheless, been stronger in the UK than in Scotland because the depth of the recession was greater in the UK. By 2014q2 Scottish GDP had grown by 6.9% since the trough of the recession compared to 7.3% in the UK to the earlier quarter 2014q1. Jobs and Unemployment

• With the signs that the growth of productive activity may be slowing, we note also the strong performance of the Scottish labour market in recent months, with 52,000 jobs created over the year and unemployment on the ILO measure falling to 151,000 or 5.5%.

• However, despite the strong recent ‘headline’ recovery in the labour market, we are still some way from the conditions that maintained prior to the start of the Great Recession.

• Much of the recovery in jobs has been driven by the growth of part-time and self-employment.

• However, there is still slack in the Scottish labour market:

• full-time employment remains considerably below its pre-recession peak, although there has been some pick up in recent quarters;

• the total number of average weekly hours worked is at the latest data point -2.4% below the pre-recession peak;

• and, the employment to adult population ratio in June-August 2014 stood at -1.5% below the pre-recession peak, compared to -5.7% at the trough of the recession.

Drivers of the recovery

• Elements of a balanced recovery are falling into place.

• Household spending is continuing to make a positive contribution to growth but its underling determinants remain weak.

• The net (international) trade position has been consistently negative in the last three quarters.

• With a weakening global market the prospects that external demand will serve to sustain growth appear unlikely. Hence the prospects for sustained investment spending would appear to depend on the growth of domestic demand and household spending in particular.

• Investment is recovering, but only slowly prompting the International Monetary Fund (IMF) to urge Governments to undertake increased public infrastructure investment. Such investment the IMF argued raises output in both the short and long term, particularly during periods of economic slack and when investment efficiency is high.

• So, in countries with infrastructure needs, it considered the time was right for an infrastructure push as borrowing costs are low and demand is weak. Debt-financed projects could have large output effects without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investment.

• The IMF notes that the estimated quality of UK infrastructure overall has been improving in recent years but still remains below that of the major advanced countries - Germany, France, Japan and Canada.

• The UK Government appears to agree since at the time of writing it is unveiling plans for £15bn of new infrastructure projects this week to make it “easier than ever” to invest in the UK. Such public investment is to be welcomed.

• However, we contend that in the light of slowing growth, the risks of secular stagnation, the need to boost competitiveness, net trade and inward foreign investment, that there is strong case that Government, and the UK Government in particular, should borrow to invest more in infrastructure in and for Scotland.

• For example, more needs to be done to improve the infrastructure of road and rail, especially, between Scotland and the UK. Raising the borrowing levels available to the Scottish Government would also help to support and encourage its own plans for infrastructure investment within Scotland.

• An expanded programme of public investment would appear to be essential when the real volume of private investment continues to be below pre-recession peak levels in both Scotland and UK, even though private investment has picked up in recent quarters. And the investment should be funded by debt not by cutting current spending or other capital spending.

Forecasts

• We are now forecasting GDP growth in Scotland of 2.7% in 2014, 2.2% in 2015, and 2.1% in 2016.

• We have therefore revised up our forecast for 2014 from 2.5% to 2.7% due to the strong growth in the first half of the year. We have held our forecast for 2015 at 2.2% but have revised down our forecast for 2016 from 2.4% to 2.1% in the light of concerns about secular stagnation and a persistent weakness of aggregate demand.

• Production and manufacturing continue to be the major sectors exhibiting the fastest growth in 2014, 2015 and 2016.

• Our forecasts for employee job creation and unemployment are similar to June 2014, with some revisions. On the central forecast, we are now forecasting that net jobs will increase by 46,560 in 2014, 41,600 in 2015 and 48,900 in 2016.

• Our projection for unemployment on the ILO measure at the end of 2014 falls to 124,700 (5.3%). In 2015, unemployment is now forecast to fall slightly to 5.2% but to increase in terms of numbers to 141,019 as the workforce increases. Falling again, to 135,537 (5.0%) by the end of 2016.

 

Comments

[Ian Jenkins]

We seem to be back to the problem of lack of demand.

Either the UK chancellor, of whatever colour, discriminates in favour of the Scottish part of the UK and allows it to borrow an extra £4bn - or we're sunk now rather than later. Such are the politics of the global economy.

The City Growth Commission is making a similar appeal for metro regions in England outside London. Their thinking is influenced by the fact that grants from the Treasury to these areas are certain to be cut substantially - and Scotland won't be protected either as John Kay suggested yesterday in the FT.

Economists from France and Germany are working on short-term fixes to their nations, never mind regions, but the recommendations for austerity and more spending on infrastructure have not even been approved by their governments as a first step before submission to the European Commission.

Change international politics?

[Ian Jenkins]

The West's lack of demand can only be solved in the immediate future by endless quantitative easing, suggested Strathclyde graduate and hedge fund manager Hugh Hendry in an interview with 'Money Week' last month.

This is reckoned to be the only way the countries can keep their public spending at levels that won't provoke riots. Because in the valueless global economy the procedure can't easily be stopped.

Of course, such debasement of the currency is not a sustainable solution, as many including the Roman empire found. Apparently we still can't change international politics.