Fraser of Allander Institute Economic Commentary Vol 39 No. 2 In association with The Scottish economy Outlook and appraisal .................................................................... 3 Forecasts of the Scottish economy ............................................... 32 Fraser of Review of Scottish Business Surveys ........................................... 43 Allander Scottish Labour Market ................................................................ 48 Economic perspectives* Institute Editorial Introduction ..................................................................... 55 Fraser Economic Commentary – The complete catalogue Economic of reviews, outlooks and articles: 1975 - 2015 George Macgregor and Isobel Sheppard ................................... 57 Commentary Forty turbulent years: How the Fraser Economic Commentary recorded the evolution of the modern Scottish economy. Part 3 - The Nice decade turns nasty; banking Armageddon; and the politics of austerity, 2001 – 2015 Alf Young ................................................................................... 68 Scotland’s Productivity Performance – Latest data and Vol 39 No 2 insights Kenny Richmond and Jennifer Turnbull ..................................... 77 Scotland’s export performance: some recent evidence Jonathan Slow, Stewart Turner & Kenny Richmond ................. 91 International Value Chains: opportunities and challenges for small and developing countries Loe Franssen ......................................................................... 101 Policy Section* Some key issues for employment and skills in Scotland: a review of emerging evidence Graham Thom and Susan Stewart ......................................... 112 Re-designing a more circular Scottish economy Ewan Mearns and Daniel Hinze.............................................. 122  University of Strathclyde, 2015 Improving lives in Scotland; a wellbeing approach The University of Strathclyde is a charitable body, Charlie Woods and Donald Jarvie ......................................... 137 registered in Scotland, number SC015263 ISSN 2046-5378 *Opinions expressed in the policy section and economic perspectives are those of the authors and not necessarily those of the Fraser of Allander Institute The Fraser of Allander Economic Commentary was first published in 1975. The partnership between PwC and the University of Strathclyde Business School provides the Fraser of Allander Institute with support to publish the Commentary, and is gratefully acknowledged. The Fraser of Allander Institute is a research unit within the Department of Economics at the University of Strathclyde in Glasgow. The Institute carries out research on the Scottish economy, including the analysis of short-term movements in economic activity. Its researchers have an international reputation in modelling regional economies, regional development and energy economics. The Institute also undertakes one-off research projects commissioned by private, public and third sector clients. If you would like further information on the Institute’s research or services, please contact the Institute Administrator on 0141 548 3958 or email the Institute at [email protected]. The Fraser of Allander Institute was established in 1975 as a result of a donation from the Hugh Fraser Foundation. 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Fraser Economic Commentary Digital Archive To mark the 40th anniversary of the Fraser Economic Commentary (and previously the Quarterly Economic Commentary) the University of Strathclyde Andersonian Library has completed the digitisation of the entire Commentary archive, from 1975 to the present day. The Commentary is now accessible via the Institute’s website and the University’s digital repository, StrathPrints. The Fraser Economic Commentary Digital Archive includes all articles, outlook and reviews and forecasts made in the Commentary and forms an important part of the Fraser’s anniversary celebrations whilst simultaneously widening public access to a significant scholarly resource as the leading publication on the Scottish economy. Fraser of Allander Institute Department of Economics t: +44 (0) 141 548 3958 University of Strathclyde f: +44 (0) 141 548 5776 Sir William Duncan Building e: [email protected] 130 Rottenrow w: http://www.strath.ac.uk/fraser/ Glasgow G4 0GE University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy The Scottish economy November 2015 2 University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy 1 Outlook and appraisal Brian Ashcroft, Economics Editor, Fraser of Allander Institute Overview 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%. The latest Scottish data contain considerable revisions from the previously published data, and one worry is whether the growth gap is genuine or will be revised away in subsequent quarters. However, despite what some prominent commentators have said about the latest GDP data providing a different picture from other Scottish data, we think that the data do tend to show an absolute and relative – to the UK – slowdown in the growth of the Scottish economy. Growth in the UK economy is slowing too. The preliminary estimate for UK GDP in the third quarter was 0.5%, with growth weakening from the 0.7% attained in the second quarter. Growth in the world economy is also forecast by the IMF to be weaker this year than last but is expected to pick up again next year. The latest data also 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 2015, employment in Scotland 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. On output, by the second quarter, Scottish GDP was 3% above the pre-recession peak while UK GDP (ex oil & gas) was more than double (6.9%) above its peak. And in terms of GDP per head, which in many ways is a better measure of the prosperity of people, in the second quarter UK GDP per head stood at +0.6% above its pre-recession peak - after nearly 6 years – while the position in Scotland is that it is worse with GDP per head in 2015q2 -0.3% below pre-recession peak. What seems to be happening is that domestic demand is still driving growth in Scotland and UK. But 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 and 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 case in point. 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 November 2015 3 University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy 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. External demand for Scottish and UK goods and services are 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 a number of 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 markdown 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; 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. It is against this background that we have prepared our latest forecasts. Our GDP forecast for 2015 is 1.9%, which is a significant revision 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 and third quarters of the year. 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. 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 as 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. 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%. 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 from our earlier forecasts. 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 6.2%, falling further to 5.7% by the end of 2016, and 4.6% by end 2017. November 2015 4 University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy In this Outlook & Appraisal we also continue our consideration of the medium to long-term challenges facing the Scottish economy. Specifically, we ask first, how are we doing over the long-term in terms of growth performance against the UK? Secondly, we ask if Scotland is to raise its long-term growth performance how well equipped is the economy to do that? And that is a question about Scotland’s economic competitiveness. On long-term growth performance, the main conclusions are: Scottish ‘trend’ GDP growth over last 50 years is identical to UK growth rate at 2.3% p.a. and 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 lower population growth in Scotland. So, while in comparison with the UK and indeed many other small and large countries, Scotland’s economic performance is ‘not too bad’, we note that there has been a relative weakening of the Scottish economy since 2010. It follows, that if Scotland is to prevent a further deterioration in performance compared to the UK and secure a sustained increase in its overall growth rate the Scottish economy will have to raise its level of competitiveness. On raising competitiveness, we show that Scottish labour productivity while growing, is weaker than in the 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 i.e. London and the South East). 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 to 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 Scotland’s overall exports to the rest of the world. In addition, there is clear evidence of the growing importance to the Scottish economy of exports to the rest of the UK, which peaked at 68% of total value of Scottish exports prior to the recession. Exports to rest of UK are heavily dominated by service sector exports and financial services in particular. Their importance dipped during and immediately after the Great Recession to 2012 with the contraction of financial services activity but it has since picked up again. Another pointer is that exports to the rest of UK track GDP much better than do 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. In the next Commentary we shall consider some of the policy issues that arise from this analysis. The issues that need to be considered include: how to raise overall exports to help drive GDP growth; how to build on the importance of the rest of UK market by selling more manufacturing products there as well as to the rest of the world; and how to raise service sector exports to the rest of the world. Recent GDP performance The latest Scottish GDP data are for the second quarter of this year (2015q2). The chained volume measure of GDP rose by 0.1% in Scotland in the quarter, while UK GDP rose by 0.7%. Over the year – November 2015 5 University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy four quarters on four quarters – Scottish and UK growth was identical at 2.7%. The Scottish and UK quarterly growth rates back to 2007q1 are presented in Figure 1. Figure 1: Scottish and UK quarterly GDP growth, 2007q1 - 2015q2 1.5 1.0 0.5 0.0 -0.5 nt e c er-1.0 P -1.5 Scotland UK -2.0 -2.5 Source: Scottish Government Gross Domestic Product 2nd Quarter 2015, and Fraser of Allander Institute (FAI) calculations The latest data contain considerable revisions from the previously published data, with overall growth lowered by -0.1% points in 2015q1 and raised by 0.1% in 2014q4. And across sectors, production output in 2015q1 is revised down by -0.3% points, which appears to be mainly due to mining and quarrying, while construction output is revised up by 0.1% and is subject to detailed, sizable revisions going back to the fourth quarter of 2012, and agriculture, forestry and fishing is revised up by 0.1%. Output in the service sector is unrevised on 2015q1 but is subject to upward revisions for the final three quarters of 2014 and downward revision in 2014q1. We are concerned about these revisions but are assured by Scottish Government statisticians that they do not reflect ‘errors’ but reflect updated survey returns from companies and changes in the seasonal adjustment factors after re-estimation to accommodate the latest data. The worry is whether the gap that has opened up between Scottish and UK performance in the second quarter of this year is real or will be revised away in subsequent quarters. However, despite what some prominent commentators have said about the latest GDP data providing a different picture from other Scottish data, we think that the data do tend to show an absolute and relative – to the UK – slowdown in the growth of the Scottish economy. On the revised data, the Scottish economy has now enjoyed positive growth for the last 12 quarters (since 2012q2) while in the UK the sustained recovery period has been slightly shorter at 10 quarters from 2013q1. However, the UK recovery from the Great Recession has overall been stronger than in Scotland as is shown in Figure 2a. November 2015 6 University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy Figure 2a: GVA Scotland and UK in recession and recovery to 2015q2 (relative to pre-recession peak) 108.00 106.00 +5.8% 104.00 102.00 +3.0% 100.00 98.00 96.00 -5.0% 94.00 92.00 -6.2% Scotland GVA UK GVA 90.00 Source: Scottish Government Gross Domestic Product 2nd Quarter 2015, and FAI calculations By the second quarter, Scottish GDP was 3% above the pre-recession peak while UK GDP was 5.8% above its peak. So, in view of the greater depth of recession in the UK, with GDP falling by -6.2% compared to a drop of -5% in Scotland, it seems clear that the UK has enjoyed a significantly (much?) stronger recovery than Scotland even though the recovery has been weaker than from any previous recession over the previous 80 years. And the data reveal that growth from the trough of the recession to the second quarter of this year amounts to 8.4% in Scotland and - 12.8% in the UK. The Scottish Government statisticians are now producing GDP per head data, which in many ways is a better measure of the prosperity of people in Scotland. In addition, recent years have seen high inward migration into the UK and Scotland, so in assessing the performance of the economy of over time we really need to control for changing population. Data for recession and recovery in GDP per head in Scotland and the UK are presented in Figure 2b. Figure 2b really puts the ’recovery’ into perspective. In the second quarter UK GDP per head stood at +0.6% above its pre-recession peak – and that after nearly 6 years! The position is worse for Scotland with GDP per head in 2015q2 -0.3% below pre-recession peak. As Oxford University’s Professor Simon Wren Lewis notes in discussing the UK recovery “… average growth in GDP per head between 1955 and 2008 was about 2.25%. Any recovery from such a deep recession should have seen growth rates well in excess of this. Instead the revised data give us 1.1% growth in 2011, 0.5% in 2012, 1.5% in 2013. November 2015 7 University of Strathclyde | Fraser of Allander Institute Economic Commentary: 39(2) Scottish economy Only by 2014 had we got near the long-term average growth rate. This is still an absolutely terrible performance for a recovery.” 1 Figure 2b: GDP per head Scotland and UK in recession and recovery to 2015q2 102 +0.6% 100 -0.3% 98 96 -5.9% 94 92 -7.0% 90 GDP per head GDP per head 88 1234123412341234123412341234123412 QQQQQQQQQQQQQQQQQQQQQQQQQQQQQQQQQQ 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Scottish Government Gross Domestic Product 2nd Quarter 2015, and FAI calculations Returning to the overall GDP data we need in comparing Scotland and the UK, as noted in previous Commentaries, to allow for the complicating factor of oil and gas production, which for offshore production is included in the UK GDP data but not in the Scottish data. Removing oil and gas production from UK GDP data gives us Figure 3 When oil and gas production is removed, we find that the gap in the strength of the recovery continues to be wider in the UK’s favour. UK GDP (ex oil & gas) stands 6.9% above the pre-recession peak compared to 3.0% in Scotland. The long period of weak UKCS oil and gas production has slowed the recovery of UK GDP from recession. So, 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 – has 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 pickup in offshore activity - and by 2.7% over the year – four quarters on four quarters. 1 http://mainlymacro.blogspot.co.uk/2015/10/following-publication-of-revised-gdp.html November 2015 8