Scottish Economy Watch

Punching above our weight

On Wednesday of this week - 9 December- the Office for National Statistics (ONS) published its annual update of Gross Value Added (GVA) and GVA per head for the Nomenclature of Units for Territorial Statistics (NUTS) 1, 2 and 3 regions and nations of the UK. This is a useful exercise although there are technical issues to be confronted in the construction of estimates of GVA across the UK regions and territories. The present data series is constructed using household income data, later this month - on 16 December to be precise - ONS will publish GVA estimates based on counting produced output: the two do not always produce the same result! A further point is that GVA is much the same as GDP. I won't go into the difference.

Anyway technical issues aside, I was interested to read In the Herald that Stewart Hosie, the SNP’s deputy leader and economic spokesman, in commenting on the publication had said

“Today’s ONS figures show, once again, that Scotland continues to punch above its weight in its contribution to the UK economy. The strong showing for Scotland is testament to the successful economic policies of the SNP Government from crucial infrastructure investment to vital support for small businesses.This has resulted in record numbers of registered businesses in Scotland, increased productivity, growing value of international exports, and record employment.”

I read these comments before I had chance to look at the ONS data. So, I thought: "That's interesting. If Scotland is 'punching above its weight it must mean that we are generating more income than our size (equals weight?) would warrant. The main indicator of a territories size is population, so according to Mr Hosie GVA per head in Scotland must now be higher than the UK. And, this might be due to SNP Government policy"  

I rushed to look at the data and the chart below is what I found:

So, the chart reveals that on a reasonable definition of "punching above its weight" Scotland lags behind the UK as a whole. Indeed, the relative is lower than it was in 1997. It is lower than it was at the trough of the recession in 2009 but the high point of 97.2 was due principally to the recession being stronger in the UK than in Scotland. Between 2009 and 2012, the Scottish relative fell as the recovery from recession in UK GDP was faster than in Scotland. After 2012 the Scottish recovery picked up and so the relative rose a bit.

But there's little in these data to suggest that Scotland has exhibited a "strong showing" at all. It is true that Scotland moved into third position in the GVA per head rankings in 2013 just ahead of East England as the recovery in Scotland strengthened and this might have been influenced by SNP government policy in prioritising investment spending and the pick up in construction activity here. But as the chart below shows all regions and nations appear to have lost out to London during the recovery. If Scotland has managed to achieve "record numbers of registered businesses in Scotland, increased productivity, growing value of international exports, and record employment", which I think is not wholly supported by the data, it has not registered much, if at all, in the GVA relative and certainly could not lead one to conclude that Scotland is "punching above its weight."

Scottish Labour Market in July-September 2015

The latest labour market data show the situation up to end September. The data clearly show the slowdown that has recently occurred in the Scottish economy. Some comfort can be perhaps be obtained from the latest quarter's data, which could be interpreted as showing that the slowdown is coming to an end. I think, however, that would be a premature conclusion until we see more data.

Employment did rise by 3,000 in the latest quarter and by 9,000 over the year. But as the chart shows there is clear evidence that job creation has been slowing down in Scotland leading employment to fall further behind the UK. So, by Jul-Sep 2015 UK employment was 5% above its pre-recession peak whereas Scottish employment was only 2.1% above.

The same conclusion can be drawn by looking at the unemployment rate which has now risen to 6% in Scotland compared to 5,3% in the UK. The next chart shows the rate in the two jurisdictions.

What is revealing from the chart is that the unemployment rate in the UK has now moved below where it was just before the recession started whereas in Scotland it is more than 40% higher.

The next chart, which graphs the employment to working population ratio shows that there is still a lot of 'slack' in the Scottish labour market.

The ratio stand at nearly 3% below its pre-recession peak. On this basis we should not expect there to be much pressure on wages in the Scottish economy.

This downturn may be the effect of the sharp fall in the price of oil and if so we should expect this to begin to unwind soon with job creation picking up and unemployment moving on a downward path again. But if not, then we might be witnessing the end of the recovery.

Business rates and the Scottish economy

Magnus Gardham writes in the Herald on Tuesday 10 November that 

'Some of Britain's biggest retailers have warned stores could be forced to shed jobs in Scotland unless business rates are overhauled. Boots, Marks & Spencer and John Lewis are among 40 firms and business organisations that have called for a fundamental reform of non-domestic rates. They say business rates, which raise £2.8billion, place an "unsustainable burden" on them. In an open letter to The Herald, they describe rates as "a tax on jobs and growth" that "acts as a drag on the Scottish economy".

Gardham also reports that John Swinney, the Finance Secretary, defended Scotland's business tax regime as "already the most competitive in the UK".

My advice to John Swinney is that he should be a little skeptical of such special pleading by a business lobby.

The theory and evidence on business property taxation offers little support for the view that Scottish business rates are "a tax on jobs and growth” - see here and here.

John Swinney could have reasonably responded to this retail lobby that business rates:

• Are only a small percentage of business costs usually ranging from 2% to 4%
• Allow many companies to obtain tax reliefs and non-domestic rates can be set against Corporation Tax.
• Allow local authority public service benefits to be received by firms; and
• That the burden of non-domestic rates is in the long run unlikely to be borne by the users of the property such as the retailer: the incidence of the tax will differ from where the tax is levied.

A key question here is the tax incidence: Who bears the burden of a property tax?

In answering this question we need to distinguish between the short run and the longer run.

 In the short run, theory and evidence suggests that the tax reduces profits, and in limited degree is shifted forward to consumers in the form of increased prices. The fact that profits of retailers and other payer of the tax may fall in the short run is likely to reduce investment and so those lobbying John Swinney do have a point. Moreover, the tax clearly introduces a distortion into the economy by disadvantaging property intensive economic activities and investments.

However, in the medium to long run the users of property will be able to negotiate a reduction in rents as a result of the tax. This is because the land and property is effectively fixed in supply, can’t be switched to other uses – especially the land = so there is little or no impact on economic behaviour. Its supply, to use an economic term, is zero elastic. Any reduction in rental value as a result of the property tax will generate a corresponding reduction in capital value. Hence this process is known as ‘tax capitalisation’. Evidence is typified by this study, which found that:

“The average capitalisation effect obtained was not significantly different from 100% implying that all of the local tax exemption benefits accrue to the owners of the property."

And this is why studies tend to find little or no effects of business rates on jobs and output in rated activities and hence why we should be skeptical of the current business lobby against the current levels of business rates in Scotland.

This does not of course mean that business rates are a ‘good tax’ and should not be abolished.

Business rates tax both land and property. As we noted above, because the supply of land is effectively zero elastic a tax on land simply takes away economic rents and does not distort behavior. However, taxes on investments in, and improvements to, property per se are a tax on business activity and so will distort behavior. The former land element of the tax is ‘good’ the latter property alone element is ‘bad’.

The logic of this argument is that John Swinney should respond to the current lobby against business rates by accepting the distorting effects of the property element and that he will seek to abolish the property element by moving towards a land value tax (LVT).

The case for replacing business rates with a LVT and the associated costs and benefits is well set out by Nobel prize winner Professor Jim Mirrlees in chapter 16 of his review of taxation in the UK for the Institute of Fiscal Studies, which can be accessed here.

It is on such rigorous theory and evidence based reviews that policy should be based and not the lobbying of self-interested groups

Never say never?

I see the well-known economist and FT columnist John Kay has suggested that the financial services sector in Scotland will never recover from the failure of its two largest banks at the height of the banking crisis in 2008. Specifically, John Kay is reported as saying that

“We’re never going to recover the position that we had for centuries in banking – and that’s a tragedy.”

On the other hand, Owen Kelly, chief executive of industry organisation Scottish Financial Enterprise, responded with the comment that

“Scotland’s diversity as a financial centre – we’re not just providing banking but also asset management, pensions, insurance, asset servicing all kinds of other services – has given us resilience. In terms of job numbers, we are roughly where we were in 2008 – a much better outcome that some were expecting."

So, what is the evidence?

On the real value of output, the evidence to date favours Professor Kay as the chart below shows

Source: Scottish Government GROSS DOMESTIC PRODUCT 2nd QUARTER 2015, and FAI calculations

The real value of output in financial services in Scotland is currently -13.4% below the sector's pre-recession peak. This is little different from the -15.5% that was lost to financial services in Scotland as a result of the recession.

But, perhaps, one should never say never!

Podcast - Fraser Commentary - November 2015

For those who can stand it the latest podcast for the Commentary is here (click on picture):

 

 

 

 

Fraser Economic Commentary - November 2015

 

I           Overview

 In the latest Economic Commentary  we note that Growth in both the Scottish and UK economies is slowing and in the second quarter a gap opened up between Scotland and the UK.

• The chained volume measure of GDP rose by 0.1% in Scotland in the quarter, while UK GDP rose by 0.7%.
• UK GDP (ex oil & gas) stands 6.9% above the pre-recession peak compared to 3.0% in Scotland. UK GDP - ex oil & gas - has had an even stronger recovery from recession than Scottish GDP.
• Scottish GDP has recovered by 8.4% since the trough of recession while UK GDP - ex oil & gas - recovered by 13.8% from its trough by 2015q2, compared to 12.8% when oil and gas output is included. In the latest quarter, UK GDP ex oil and gas rose by 0.5% - less than the 0.7% when oil & gas is included, suggesting a pick up in offshore activity - and by 2.7% over the year – four quarter on four quarter.

 

II          Industries and sectors

 The pattern of growth between Scotland and the UK again differed considerably in the fourth quarter. 

• In Scotland it is the construction sector that is providing the main impetus with public spending on infrastructure underpinning growth.
• In the UK in contrast, the service sector is the main driver with construction weakening.
• In Scotland, weakness in the service sector has been affected by the onshore implications of the fall in the price of oil hitting business services in particular as well as mining and quarrying. 
• Manufacturing growth is weak in both Scotland and the UK, which seems to be a reflection of weakening external demand for UK exports reinforced by the strength of sterling, the current crisis in the UK steel industry being a sad, example.

 

III         The labour market

 The latest labour market data show that the recovery in the labour market is slowing in both Scotland and the UK, while the recovery remains stronger in the UK.

• In the quarter to August 2105 employment fell by -6,000 (-0.6%) to 2,610,000 while unemployment rose again by 18,000 (0.6%) to 170,000 with the rate rising to 6.1%.
• In both the jobs market and in output the recovery has been stronger in the UK than in Scotland. On jobs, employment was 2.2% above the pre-recession peak in Scotland at the end of the second quarter, while UK jobs were 4.4% higher than the peak.

 

IV         Factors influencing the recovery

 (i)             Domestic demand

 Domestic demand in Scotland and the UK continues to be boosted by:

• low inflation;
• net immigration into the UK;
• low interest rates; and some pick up in wages and earnings.

 To be set against these positive influences are actual and potential threats to the growth of domestic demand:

• further planned austerity by the UK Conservative Government exemplified by the planned cuts to tax credits; and
• the continuing high levels of household debt, which for some households paying a variable interest rate will become an increasing burden if rates rise in the near future.

 (ii)           External demand

 External demand for Scottish and UK goods and services is being boosted by:

• the continued resilience of the US economy;
• a gradual pick up in growth in the Eurozone as the risks of deflation appear to recede while the problems of Greece are, for the short term at least, resolved;
• and the world economy is forecast by the IMF to grow by 3.1% this year and by 3.6 % in 2016.

 To be set against these positive influences are actual and potential threats to the growth of external demand:

• the high sterling exchange rate against the Euro, which appears to have been boosted by the short-term market expectation of an imminent increase in UK interest rates;
•  the IMF’s forecast for global growth in 2015 and 2016 represents a slowdown from the 3.4% achieved in 2014;
• China’s transformation from dependency on high domestic investment, forced saving and a disproportionate reliance on external demand to a greater reliance on household consumption and associated structural reforms will lead to slower growth; and
•  the effect of what the IMF calls ‘policy normalisation’ of monetary policy in the United States as interest rates begin to rise is expected to have global repercussions, which will serve to slow growth especially in emerging markets.

 

 V          Forecasts

 (i)             Output

• Our GDP forecast for 2015 is 1.9%, which is revised down from our forecast of 2.5% in June of this year due to the evidence of a slower than expected rate of growth in the second third quarters of 2015.
• For 2016, we have also revised down our forecast to 2.2% from 2.3% in June, in recognition that the slow down in the rate of recovery will continue into 2016 as exporting continues to be difficult due to the high pound sterling and because of the lingering effects on Scottish onshore activity of the low price of oil.
• 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. We have therefore raised our forecast for 2017 to 2.5% from 2.3% in our June forecast.

 (ii)           Jobs

• The number of total employee jobs is forecast to continue to increase in each year, and at a faster rate than that seen during 2014 (although not as strongly as in 2013).
• Our forecast for the number of jobs added in 2015 has been revised down since June’s forecast, from 51,250 to 49,400. The number of jobs at the end of 2015 is now forecast to be 2,433,400, an increase of 2.1% on 2014 (the same percentage growth forecast in June’s Commentary).
• Our current central forecast is that the Scottish economy will add 45,000 jobs in 2016, down by 4,600 from our June forecast, while we forecast the addition of 54,650 jobs in 2017, an increase of nearly 3,000 on our June forecast.

 (iii)          Unemployment

• On unemployment, the most recent figures show that unemployment rose again by 18,000 (0.6%) to 170,000 with the rate rising to 6.1%. Unemployment in Scotland rose by 19,000 over the year, or 0.7%.
• Despite the recent increases, the improvement in the labour market is forecast to continue with unemployment rates and numbers falling to end 2017.
• Our projection for unemployment on the ILO measure at the end of 2015 is 169,150 (6.2%), falling further to 155,450 (5.7%) by the end of 2016, and 118,400 (4.6%) by end 2017.

 

 

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	2.2	2.5
June forecast	2.5	2.3	2.3
UK mean independent new forecasts (October)	2.5	2.3
Mean Absolute Error % points	+/- 0.26	+/- 0.80	+/- 1.37

© Fraser of Allander Institute, November 2015

 

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

	2015	2016	2017
Upper	54,950	65,500	88,800
June forecast	62,100	72,650	80,600.
Central	49,400	45,000	54,650
June forecast	51,250	49,600	51,700
Lower	43,800	24,450	20,500
June forecast	40,400	26,550	22,800

© Fraser of Allander Institute, November 2015

 

 

Table 3: Forecasts ILO unemployment 2015-2017

ILO unemployment	2015	2016	2017
Rate (ILO un/TEA 16+) June forecast	6.2% 5.1%	5.7% 4.5%	4.6% 3.9%
Numbers	169,150	155,450	118,400

 © Fraser of Allander Institute, November 2015

 

  (V) Growth

 Analysis by the Institute 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 over last 50 years is identical to UK growth at 2.3% p.a;
• Scottish ‘trend’ GDP per head growth over last 50 years is 2.2% p.a. faster than UK’s 2% p.a. – due to falling or slower population growth in Scotland.
• We note that there has been a relative weakening of the Scottish economy since 2010.
• It follows, that to secure a sustained increase in the growth rate overall the economy will have to raise its competitiveness.

 

On raising competitiveness, we show that Scottish labour productivity while growing is weaker than in UK.

• We cite recent research evidence from Durham University’s Professor Richard Harris and Dr. John Moffat that Total Factor Productivity (TFP)  - the productivity of all factors: labour, capital and land – is also lower in Scotland than UK.
• They find that on average Scotland has had significantly lower productivity compared to the rest of the UK since the end of the 1990s. Overall, the ‘gap’ was around 11% across all sectors in 2012 (and 22% below the leading UK region).
• There is an academic and policy consensus that we get stronger productivity growth through improvements in: innovation/R&D; exporting (especially in small open economies); skills; investment, and enterprise.
• Scotland is shown to be weak in varying degrees on all of these determinants of competitiveness.
• We look particularly at export performance and find that there has been a long-term decline – since the early 2000’s - in manufacturing exports abroad. This has affected the performance of overall exports to the rest of the world.
• In addition, there is clear evidence of the growing importance of exports to the rest of the UK, which peaked at 68% of total Scottish exports before the recession. Exports to rest of UK are heavily dominated by service sector exports and financial services in particular. That importance dipped during and immediately after the Great Recession to 2012 with the contraction of financial services activity but picked up again after that.
• Another pointer is that exports to the rest of UK track GDP much better than exports to the rest of the world. This in part reflects the scale of rest of the UK exports to both GDP and total Scottish exports

Fraser Economic Commentary - June 2015

 

I           Overview

In the latest Economic Commentary we note that the Scottish and UK economies are continuing to grow and recover from the Great Recession. With growth of 0.6% in the final quarter of last year – the latest data point - the Scottish economy has now enjoyed positive growth for the last 11 quarters (since 2012q1) while in the UK, also with growth of 0.6% in 2014q4, the sustained recovery period has been shorter at 8 quarters. But the recovery continues to be stronger in the UK.

When oil and gas production is removed – to compare like with like, since offshore activity is included in the UK but not the Scottish GDP data - we find that the gap in the strength of the recovery widens further in the UK’s favour. UK GDP stands 5.1% above the pre-recession peak compared to only 2.3% in Scotland. We speculate that the relatively stronger UK recovery under the new accounting system ESA 2010, under which the latest data were generated, could be due to the recovery in R&D activity being stronger in the rest of the UK after the recession than in Scotland and, if so, may not augur well for Scotland’s growth performance in the longer term. However, there may simply be a technical rather than an economic cause due, for example, to different sub-sectoral weights between Scotland and the UK.

 

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 differed considerably in the fourth quarter.  In the UK, the service sector was by far the main driver of growth, while in Scotland the sector made no contribution to growth. In contrast, the principal driver of growth in Scotland was the construction sector while the sector in the UK was a drag on growth. In addition, the production sector contributed about a third of the growth in Scotland but made no contribution to growth in the UK. Within production, manufacturing in both Scotland and the UK made no contribution to growth, while in Scotland it was mining & quarrying and electricity & gas that provided the contribution to growth.

 

III         The labour market

The latest labour market data show that jobs continue to be created at a fairly fast pace, indeed in the latest February – April 2015 quarter at a faster rate in Scotland than the UK both in the quarter and over the year. However, the picture differs on unemployment with the numbers seeking work rising slightly in the latest quarter and the reduction over the year, while sizeable  is proportionately less than in the UK. By the end of the fourth quarter, Scottish jobs as reported in the LFS household surveys were 2.6% above the pre-recession peak, while UK jobs were 4.6% higher than the peak. So, the latest data show the recovery in the labour market to be continuing but there is now some evidence that the rate of recovery is slowing in Scotland and despite recent stronger Scottish jobs growth overall the recovery remains stronger in the UK.

 

IV         Progress of the recovery

Our conclusion on capacity utilisation is that despite the recovery the Scottish economy still has spare capacity available, most notably in the labour market where the number of total weekly hours worked in Scotland was close to but still -0.4% below the pre-recession peak. Moreover, by January - March 2015, the ratio of employment to working population stood at -2.4% below the pre-recession peak, a worsening of the position in the final quarter of last year, compared to -6.7% at the trough of the recession. In the UK as a whole, in contrast, the ratio is only -0.6% below its pre-recession peak but still below a peak that was attained 7 years ago.

 

(i)        Positive influences on the recovery

We note that there are clear positive influences boosting the demand for Scottish goods and services:

• Domestic demand is still growing strongly boosted by investment (see below);
•  Domestic inflation is close to zero, below nominal earnings/income growth and so boosting real income; and
•  External demand remains reasonably strong, with growth in the euro area beginning to strengthen while US growth having faltered earlier in the year looks set to pick up again.

 

 Yet, there are continuing threats to the further recovery of demand which policy should seek to minimise.

 

(ii)       Threats to the recovery

 

•  First, growth remains unbalanced with household spending the key driver fuelled largely by rising household debt, which we fear may soon become unsustainable. The growth of imports continues strongly outstripping the relatively weak growth of exports and so net trade acts as a drag on growth. Policy must seek ways of boosting exporting performance because it is becoming clearer that a more competitive price through a lower sterling exchange rate is insufficient to boost export demand. Issues of product quality and marketing would appear to be at the root of this Scottish and UK problem. One bright spot in this picture of unbalanced growth of demand is the performance of capital investment, which is now contributing significantly to demand and the growth of output in Scotland. Infrastructure spending is playing a big role in Scotland – think the new Forth Road Bridge – but also foreign direct investment where Scotland again enjoyed a successful year in 2014 with over 80 inward investment projects attracted.

• Secondly, the victory of the Conservatives with a small majority in the May UK General Election appears likely to lead to a continuation and perhaps a tightening of the previous Conservative / Liberal Democrat Coalition austerity plans. We shall find out more in the Chancellor’s forthcoming Budget. With more austerity households can expect a further reduction in their incomes, on average. What that means is that household spending will also be reduced and the fall is likely to be greater the more quickly the Chancellor seeks to bring the UK government’s budget into balance. Austerity will continue to be a major drag on capacity utilisation and economic recovery in Scotland and the UK.

• Finally, there is Greece. At the time of writing we do not know the outcome of the negotiations between the Greek government and its creditors. The risks of Greece both defaulting on its debt and leaving the euro have increased since we last reported. This issue is again fast becoming a major threat to the recovery not simply in the eurozone but perhaps, with the possibility of contagion, in the rest of the world, including Scotland.

 

It is against this background that we have prepared our latest forecasts.

 

V          Forecasts

 (i)        Output

Our GDP forecast for 2015 is 2.5%, which is revised down slightly from our forecast of 2.6% in March of this year due to the evidence of a slowing of the rate of growth through the first half of the year. For 2016, we have also revised down our forecast to 2.3% from 2.4% in March, in recognition that while the recovery is continuing the growth of demand is now anticipated to be slightly weaker than previously thought. We also are prepared to acknowledge that the negative effects of the oil price fall on the oil production and services, may be a little greater than we anticipated in March. We are forecasting 2017 for the first time and the underlying determinants suggest that growth will be little different from 2016 and so we retain the forecast of 2.3% for 2017.

 

(ii)       Jobs

The number of total employee jobs is forecast to continue to increase in each year of the forecast horizon 2015 to 2017, and at a faster rate than that seen during 2014 (although not as strongly as in 2013). Our forecast for the number of jobs added in 2015 has been revised down marginally since March’s forecast, from 51,350 to 51,250. The number of jobs at the end of 2015 is now forecast to be 2,444,250, an increase of 2.1% in 2014. Our current forecast is that the Scottish economy will add 49,600 jobs in 2016, down by 8,000 from our March forecast, while we forecast the addition of 51,700 jobs in 2017.

 

 (iii)     Unemployment

Given the small revisions to the growth in employee jobs over the next two years in our latest forecasts, there are only small revisions to the levels and rates of unemployment from our earlier forecasts. The improvement in the labour market is forecast to continue with unemployment rates and numbers falling to end 2017. Our projection for unemployment on the ILO measure at the end of 2015 is 138,200 (5.1%), falling further to 122,364 (4.5%) by the end of 2016, and 108,150 (3.9%) by end 2017. It is worth noting that our unemployment forecast for 2017 means that the unemployment rate finally falls to where it stood when the Great Recession started in 2008, nine long years ago.

Why we should be concerned about further planned austerity

In the latest Fraser Economic Commentary we discuss the threat to the Scottish and UK economies of the UK Coalition's current plans to increase the pace and scale of austerity  over the next 4 years.

The Institute for Fiscal Studies in their IFS Green Budget 2015 highlight the scale of the UK government’s recent and planned fiscal consolidation programme. The IFS analysis shows that by 2014 £110bn of fiscal tightening measures had been implemented. A further £92bn of fiscal tightening is currently planned. So, on this measure 55% of planned fiscal consolidation has been completed with 45% still to come.

Of the further planned fiscal tightening, a comparison of IMF forecasts for structural borrowing in 32 advanced economies shows that the UK has the largest planned fiscal consolidation between 2015 and 2019 and the 18th largest (or 15th smallest) planned structural deficit in 2019. Some £200 billion of fiscal tightening is nearly 13% of GDP.

If we assume a multiplier of 1.5 – not unreasonable when interest rates are close to zero and there is no scope for countervailing monetary policy - the policy would have served to have reduced GDP by 10% up to 2014 and by a further 9% by 2019.

This doesn’t mean that GDP will fall by 9% between now and 2019 but does imply that private sector output must rise by a substantial amount if GDP growth is to remain in positive territory. Specifically, if the economy is to grow at around 2.5% per annum then the underlying growth rate of the private sector in the face of such anticipated fiscal consolidation would need to be of the order of 4% per annum: a big challenge for the private sector.

The outcome will also be dependent on the result of the General Election in May 2015 because the Labour and Liberal Democrat parties are planning a slower pace of fiscal consolidation and a Conservative or indeed an unspecified Coalition government might alter the scale and pace of current plans or bias any consolidation more towards tax rises than via spending cuts, which could have a different impact on growth.

Why the fall in the price of oil could benefit the Scottish economy.

The underlying basis for the estimate in Fraser of Allander Institute's latest Economic Commentary that the fall in the price of oil could raise Scottish GDP growth is given in the box below:

Fraser Economic Commentary - March 2015

Our latest Economic Commentary, which was published today can be accessed here.

A summary of our findings and forecasts is provide below:

Overview

•  The Scottish and UK economies are now recovering at a reasonable rate from the greatest economic shock since the 1930s. This recovery, slowed by the UK Coalition Government’s austerity programme, has taken longer than from the 1930s Depression or any of the three other recessions experienced since the 1970s.
• But while growth is continuing, the pace of growth seemed to have slowed a little towards the end of 2014.
• The jobs market and unemployment have recovered more strongly than output, resulting in falling labour productivity and hence little improvement in real wages and real household incomes.
• Unemployment now stands at 5.4% in Scotland and 5.7% in UK.
• Despite the better headline unemployment figures in Scotland, there is still more ‘slack’ in the Scottish labour market than in the UK and so despite jobs growth there is little upward pressure on wages.

 

We ask: will the recovery continue? We identify several positive and negative influences that will impact on the pace of the recovery. We examine them under four headings: growth in markets; oil prices, inflation and deflation; UK fiscal and monetary policy; and Greece and the Eurozone.

 

Growth in markets

The key points here are:

• Despite the steady growth in world trade the latest IMF and OECD forecasts suggest a slowing in key countries and Scotland’s key export markets.
• The composition of Scottish and UK growth also continues to be unbalanced with household spending driving growth, and fixed investment making a variable contribution. 
• As we have stressed in recent Commentaries, household spending is being fuelled by rising debt, which is almost certainly unsustainable.
• If the economy is to rely on continued growth in household spending it requires a sustained rise in the real wages and incomes of households. However, this is unlikely to occur unless labour productivity improves, which has been badly hit as a consequence of the Great recession.

 

Oil prices, inflation and deflation

• Inflation is falling right across the global economy. There is a clearly a risk of deflation – a sustained falling price level, leading to expectations of further price falls, postponed spending and reduced spending as the real value of household and corporate debt rises.
• However, while the risk is there for the UK and the US, at this stage it is more apparent than real. Core inflation is around 1.6% in the US and close to 2% in the UK.
• The fall in oil prices has been large, around 50% at the time of writing, and the potential for a sizable boost to spending is significant with some respected analysts forecasting a 0.5% boost to UK GDP in 2015.
• I’ll discuss our estimates of the impact of this fall after Grant has spoken about some of the related issues

 

UK fiscal and monetary policy

• The base rate set by the Bank of England’s Monetary Policy Committee (MPC) is likely to remain at 0.5% for the remainder of this year. So monetary policy should remain accommodating to growth for the foreseeable future.
• The same cannot be said for fiscal policy in the UK.  
• The UK Coalition plans a further £92 billion of fiscal tightening by 2019 if they win the election - more than £200bn in total or a direct reduction in GDP of 13%.
• We estimate, that if the economy is to grow at around 2.5% per annum then the underlying growth rate in the face of such anticipated fiscal consolidation – which might change after the UK General Election in May - would need to be about 4% per annum: a big challenge for the private sector.

 

Greece and the Eurozone

• The new Greek Government led by the Syriza party came to power with a mandate to renegotiate the terms of the 2012 bailout, which most analysts agree is imposing a severe burden on the Greek economy and society.
• GDP has fallen by 25% since 2007 and unemployment is currently over 25%, with youth unemployment 50%! No other democratic country has endured austerity of such size and pace.
• If by June 2015 there is not agreement on a reduction in the pace of austerity, then there is a real risk of ‘Grexit’, that is a Greek exit from the Eurozone.
• This would have significant economic and political consequences for the Eurozone itself and for the global economy, including the Scottish economy.
• When the threat of Grexit was last posed in 2012, the Fraser of Allander Institute undertook a modelling exercise which estimated that a Greek exit would lower Scottish GDP by -1.2% and reduce employment by 49,000 and this is before estimating the potentially greater impact of a wider contagion of bank runs and possible further withdrawals of other peripheral countries from the Eurozone.

 

Forecasts

• Notwithstanding the developments above, we are forecasting growth of 2.8% in 2014, 2.6% in 2015, and 2.4% in 2016, an upward revision to our November 2014 forecasts.  These reflect our view that household spending and investment are stronger than we projected in November.
• We have also raised our forecasts for employee job creation compared to our November forecasts. On the central forecast, we are now forecasting that net jobs will increase by 53,850 in 2014, 51,350 in 2015 and 57,600 in 2016. Our unemployment forecasts have been revised down further again from November, reflecting higher economic activity.
• Our projection for unemployment on the ILO measure at the end of 2015 is 136,600 (5.0%), falling further to 125,250 (4.6%) by the end of 2016.