FAI Economic Commentary March 2016

Unfortunately, a bout of sickness has delayed me posting a summary of the latest FAI Economic Commentary. Here it is, and apologies for the delay:

I           Overview

 In our latest Economic Commentary we note that Growth in both the Scottish and UK economies is set to slow further with falling oil prices having a net negative impact on Scotland compared to the rest of the UK.

• The chained volume measure of GDP rose by 0.1% in Scotland in the third quarter, 2015, (the latest data point) while UK GDP rose by 0.4%.
• UK GDP (ex oil & gas) now stands 7.1% above the pre-recession peak compared to only 3.1% in Scotland. UK GDP - ex oil & gas - has had an even stronger recovery from recession than Scottish GDP and UK GDP as a whole.
• Scottish GDP has recovered by 8.6% since the trough of recession while UK GDP - ex oil & gas – has recovered by 14.0% from its trough by 2015q3, compared to 13.0% when oil and gas output is included.
• In the third quarter, UK GDP ex oil and gas rose by 0.5% - more than the 0.4% reported when oil & gas is included - and by 2.3% over the year, four quarters on four quarters.

II          Industries and sectors

When we examine the performance across different industries and sectors, we see that the pattern of growth between Scotland and the UK again differed in the third quarter, but the divergence was probably less than in some earlier quarters.

• In the UK, the service sector was again by far the main driver of the overall growth rate of 0.4% by contributing growth of +0.5% points. In Scotland the service sector was also the main driver of growth contributing +0.2% points.
• The construction sector, which was the main driver of Scottish growth in the second quarter still continued to contribute positively but by only +0.1% in the third quarter, while the sector’s contribution to UK growth was again negative at -0.1% points.
• The production sector continued the pattern begun in the second quarter of contributing negatively to growth in Scotland - by -0.2% in the third quarter - while making neither a positive or negative contribution to growth in the UK.
• Within production, manufacturing in the UK made no contribution to growth, while making a negative contribution -0.1% points in Scotland, a continuation of the performance in the second quarter but a reversal of the earlier pattern. In Scotland electricity & gas also made a negative contribution to growth of -0.1% points, with the other production sub-sectors neither providing a positive or negative contribution to Scottish growth. The production sub-sectors in the UK all made a zero contribution to growth.
• Despite the stronger performance of the service sector in Scotland, financial services activity continued to weaken with the prospect of recovery to pre-recession levels of activity now looking less and less likely.
• The weakness of financial services and the negative impact of the low price of oil on business services were not, however, sufficient to halt the growth of business and financial services overall, which still grew by 0.3% in the 3rd quarter and by 1.4% over the year.

III         The labour market

 The weakness in Scotland’s GDP growth has not yet impacted overmuch on the labour market.

• In the quarter to December 2015 employment rose by 22,000 (0.8%) to 2,636,000 while unemployment fell by 5,000 (-2.8%) to 162,000 with the rate falling to 5.8%.
• Yet, the jobs recovery remains weaker than in the UK as a whole. By the end of the third quarter, Scottish jobs as reported in the LFS household surveys were 3.2% above the pre-recession peak, while UK jobs were 5.7% above peak.

IV         Factors influencing the recovery and growth

•  Positive Influences

• Domestic demand is still growing helped by the income effect of a low price of oil but may be beginning to slow as investment especially public infrastructure investment growth tails off.
• Domestic inflation is close to zero, below nominal earnings/income growth, which is picking up slowly and so boosting real income;
• Interest rates remain low and household demand boosted by some pick up in wages and earnings.
• External demand for goods and services is being boosted by: the continued resilience of the US economy – despite the slowdown in US growth in the 4th quarter (and US growth was greater than UK growth in 2015 overall); and a gradual pick up in growth in the Eurozone as the risks of deflation appear to recede.

• Threats

• The low price of oil appears to be having a negative effect on Scottish growth, with negative supply effect outweighing positive demand effect. This negative effect is being sustained as the longer than expected delay in the recovery of oil prices is dampening overall investment expenditure.
• Growth remains unbalanced with household spending the key driver fuelled largely by rising household debt. Household net assets are also high so there is a debate about the significance to demand of rising debt.
• Net trade continues to be strongly negative with export demand threatened by the high level of sterling – although note the recent fall – slowdown in China and ‘policy normalisation’ in United States.
• Fiscal austerity continues in the UK, although the tightness of fiscal policy was loosened after November’s Autumn Statement. The risk is that the Government fails to meet its fiscal targets as tax revenues fail to meet expectations and the government re-intensifies austerity in order to attain its targets. This appears to be about to happen in the forthcoming Budget as signalled by the Chancellor’s comments in China. If so, this would, in our view, be a major mistake. A fiscal tightening when growth is slowing is likely to slow growth further and reduce the tax revenues that the Chancellor desires to meet his fiscal targets.
• The referendum on the UK’s membership of the EU announced for 23 June 2016 increases uncertainty significantly in the short term, which is likely to have a negative effect on investment as plans are postponed until the outcome is clear. Moreover, if UK voters do vote to leave the EU, this short-term negative impact on investment and growth is likely to carry over into the long term

 

Growth

Further analysis using new data on the long-term growth performance of the Scotland’s economy leads to the following conclusions:

On long-term growth performance, the main conclusions are:

• Scottish ‘trend’ GDP growth of 2.1% p.a. over the last 50 years is lower than UK growth of 2.4% p.a. (under the former ESA 1995, Scotland’s ‘trend’ GDP growth rate over last 50 years was identical to UK growth at 2.3% p.a.)
• Scottish ‘trend’ GDP per head growth over last 50 years is 2.0% p.a., the same as in the UK as a whole (under the former ESA 1995, Scotland’s ‘trend’ GDP per head growth rate was 2.2% p.a., faster than UK’s 2% p.a. – due to falling or slower population growth in Scotland).
• Overall Scottish growth has been consistently weaker than UK growth since the 1970s, but up until the recent recovery the gap seems to have been narrowing.
• After weakness in the 1970s and ’80s, GDP per head growth was stronger in Scotland relative to UK, until the recent recovery.

On productivity, the main conclusions are:

• Labour productivity has risen absolutely in Scotland by 22% between 1998 and 2014
• Despite this growth it fell behind the UK, which had faster growth to 2007, before the Great Recession.
• Scotland’s relativity improved during and after the Great Recession, with the UK experiencing a greater deterioration in productivity - hence the post-recession ‘productivity puzzle’ is much more of a UK than Scottish phenomenon. However, by 2014 it was still about 2.4% below the UK.
• However, academic research suggests that overall – i.e. ‘Total Factor’ – productivity in Scotland is much lower than rest of UK. In the absence of faster population growth, Scotland can only sustain an improved growth rate by raising its competitiveness through improved productivity.

V          Brexit

The Institute’s analysis of the implications of Brexit for the Scottish economy leads to the conclusion that it is difficult to imagine that it would help improve Scotland’s competitive position with respect to our trade with the EU.

• In recent years, the decline in electronics production and the erosion of Scotland’s manufacturing base has meant that Scotland has struggled to maintain its penetration of EU markets even on the favourable trading terms obtained through membership.
• It is difficult to see how any post BREXIT trading relationship with the EU would be better than current arrangements.
• So, not only would actual and potential Scottish exporters have to overcome their weaker competitive position due to lower labour and total factor productivity they would face the additional hurdle of less favourable trading arrangements.
• Moreover, Brexit might worsen Scottish productivity growth particularly via the negative effects on trade, inward investment and financial integration.
• There are several academic studies that seek to identify the impact of Brexit on the UK economy.
• One key study in 2014, by the Centre of Economic Policy (CEP) at the London School of Economics, estimated that UK GDP would be reduced by up to 9.5% of GDP in a world where the UK cannot negotiate favourable trade terms with the EU. However, under a more optimistic scenario, in which the UK secures a free trade agreement with the EU, CEP estimates the losses to be around 2.2% of GDP. The static trade welfare effects of Brexit – i.e. the loss of trade creation benefits - are estimated by CEP to range from 1.1% to 3.1% of GDP. However, once the estimated dynamic losses of Brexit on productivity growth through reduced competition and reduced technological innovation linked to lower FDI inflows and reduced financial integration, CEP’s estimates of loss rise to 2.2% to 9.5%. 

VI         Forecasts

• Output

On GDP, our forecast for 2015 – for which we do not have official 4th quarter data until April 2106 - is 1.9%, which is a slight revision down from our forecast of 2.0% in November 2015.

• For 2016, we have also revised down our forecast from 2.2% in November to 1.9%. This is mainly driven by apparently slowing income growth, a weakening of previously strong domestic investment growth, and an extension of the expected period in which a low price of oil is likely to be sustained.
• On our central forecast, we are forecasting a pick up in the rate of growth in 2017 as the economy rides out the challenges of 2016 and the price of oil in particular begins to rise to more favourable levels. But at 2.2% our forecast of 2017 remains below our November forecast of 2.5%.

• Jobs

The number of employee jobs is forecast to increase in each year, and the number of jobs added in 2015, 2016 and 2017 has been revised down slightly since our November 2015 forecast.

• The number of jobs at the end of 2015 is now forecast to be 2,415,200, an increase of 1.3% during 2015.
• Our new central forecast is that the Scottish economy will add 36,800 jobs in 2016, down by around 9,000 from our November forecast, with a net of 46,850 jobs added in 2017, down by almost 8,000 from our November forecast.

• Unemployment

On unemployment, our latest forecasts for the unemployment rate in Scotland for the end of 2016 and 2017 are 5.7% and 4.8% and for numbers 153,350 and 159,850, respectively.

 

Annex: Fraser of Allander Institute Forecast Tables

 

Table 1: Forecast Scottish GVA Growth, 2015-2017

GVA Growth (% per annum)	2015	2016	2017
Central forecast	1.9	1.9	2.2
November forecast	1.9	2.2	2.5
UK mean independent new forecasts (February)	2.2	2.1	2.2
Mean Absolute Error % points	+/- 0.16	+/- 0.64	+/- 1.37

© Fraser of Allander Institute, March 2016

 

Table 2: Forecast Scottish Net Jobs Growth in Three Scenarios, 2015-2017

	2015	2016	2017
Upper	35,650	50,700	79,400
November forecast	54,950	65,500	88,800
Central	31,200	36,800	46,850
November forecast	49,400	45,000	54,650
Lower	26,850	24,250	31,200
November forecast	43,800	24,450	20,500

© Fraser of Allander Institute, March 2016

Table 3: Forecasts ILO unemployment 2015-2017

ILO unemployment	2015	2016	2017
Rate (ILO un/TEA 16+) November forecast	5.8% 6.2%	5.7% 5.7%	4.8% 4.6%
Numbers	162,000	153,350	159,850

© Fraser of Allander Institute, March 2016