Now the time for Scottish Government to show it can rebalance the economy

With the economy bound to be one of the key election battlegrounds, Holyrood asks a number of economists to sum up Scotland’s economic outlook for the year ahead.

As we embark on 2015, the potential for political challenge in the run up to and possibly in the aftermath of May’s General Election could have an impact on the Scottish economy. So expect to see some volatility in the financial and foreign exchange markets. 

Nonetheless, the likelihood is that the recovery will continue, with the Scottish economy growing by c2 per cent in 2015 – a lower rate than 2014 – compared to the UK average of around 2.5 per cent. That’s being borne out by recent measures of business confidence – the Purchasing Managers Index – which has indicated less optimism in Scotland than in the rest of the UK. 

From an “Economics 101” perspective, the four main elements of demand: consumption, investment, government spending and trade, are the key determinants of the economic activity, at least in the short to medium term. Admittedly, over a longer time, supply factors such as the level of competition in Scottish domestic markets, the capacity for innovation, supplies of skilled labour and the effectiveness of institutions all come into play. But in order to consider prospects for 2015 it’s worth reviewing each of the Scottish components of demand. 

In Scotland, as in the rest of the UK, consumer spending has been a major driver of the recovery since 2010, with much of the growth in consumer spending being fuelled by households running down their rate of savings. The scope to continue to do that in 2015 will be limited. More positively, the likelihood is that in the rest of the UK real wages will begin to grow again in 2015 and Scotland may share in this development. 

The latest Fraser of Allander commentary stated that investment contributed more to overall economic growth than consumption during the six months to the end of March 2014, while others suggest Scottish business activity and investment may be slackening slightly. While some indicators suggest that growth in Scottish business investment has out-grown the pace in the rest of the UK, in recent years it is also the case that in one particular area – rates of business spending on R&D- Scotland continues to lag. 

December’s UK Autumn Statement indicated even greater austerity for 2015-16 and, indeed, that austerity will continue until the end of the decade. The likelihood is therefore that UK departmental spending will be further constrained in 2015 which will make a negative contribution to growth. 

So far, in Scotland as in the rest of the UK, the struggle to maintain export growth ahead of import growth means that trade has made little or even negative contributions to the overall economic recovery. In fact, Fraser of Allander suggests that net trade made a negative contribution to growth between Q3 2013 and the end of Q1 2014. One of the surprises in the second half of 2014 was the way in which global oil prices slumped by about one-half. While there can be no certainty that the oil price will remain at a six-year low of around $46 a barrel (at the time of writing) it seems likely that it will be some time before we see a return to, say, $100. Given that, expect a hit to both Scottish export values and the level of investment in development of North Sea oil and gas, particularly given recent commentary that a price of about $60/barrel was the commercial break-even point for North Sea production. 

That said, we should not overlook what is happening to export performance across other sectors. After all, even before the recent price tumbles, the value of Scottish food and drink exports exceeded those of refined petroleum products. In 2012, for example, Scotland exported about £520m to China, according to the Global Connections Survey, exposing exports such as whisky to any further deceleration in Chinese growth. As regards the crucial Eurozone markets, the likelihood is that sterling will remain strong against the Euro and may even appreciate more if the European Central Bank is forced to introduce Quantitative Easing. It is worth noting that One Scotland, the Scottish Government’s Programme for Scotland 2014-15, “includes a commitment to increase non-oil and gas exports by 50% by 2017” – this will go some way to easing the pressures arising from this sector,  although it remains to be seen if it is achievable. 

So, if there is a time for Scottish Government to demonstrate that it can rebalance the Scottish economy that time is now.

Dr Esmond Birnie, chief economist for PwC in Scotland and Northern Ireland