Room for growth: overview of the Scottish economy

George Bernard Shaw once said “the love of economy is the root of all virtue.” In government it might be said that the love of the economy is the root of all virtue. Certainly it is the key area in which any party will be judged to be competent or otherwise, and on which most other policy areas stand or fall. And with more tax-raising powers about to be devolved to Scotland, the performance of the Scottish economy will become even more important.

The economic figures released by the Scottish Government this month show a rise of 0.1 per cent in Scottish GDP in the third quarter of 2015. This follows rises in Scottish GDP of 0.1 per cent in the second quarter of 2015 and 0.6 per cent in the first quarter. The quarterly figure for the third quarter of 2014 was 0.6 per cent. Annual growth in Scottish GDP was 1.7 per cent in the 12 months to September 2015, while the annual growth in the same period in 2014 was three per cent.

Although the Scottish economy has grown for three years and is now 3.1 per cent above pre-recession levels, these latest figures contrast with the growth of 0.4 per cent in the UK as a whole in the third quarter of 2015 and 2.1 per cent in the 12 months to September 2015 reported by the Office for National Statistics, showing that although the Scottish economy is growing, it is doing so more slowly than the UK as a whole. GDP per head of population rose 0.3 per cent in Q3 of 2015 in the UK as a whole, but remained flat in Scotland.

Below these headline figures there was a great deal of variation from sector to sector. The services sector, which accounts for a third of the Scottish economy, grew by 0.3 per cent in the third quarter of 2015 and 0.7 per cent over the year, construction expanded by 0.9 per cent and 17.3 per cent over the year, but manufacturing contracted by one per cent in the third quarter. There was, however, sub-sector growth within that of 2.7 per cent in food and drink.

Deputy First Minster John Swinney called it “a period of significant challenge for our key export markets and in particular for the energy sector in Scotland given the impact of lower commodity prices.”

Commenting on the figures, he said: “The statistics […] show that the Scottish economy, like that of the UK, is continuing to feel the effect of significant challenges such as a slowdown in global demand – a situation exacerbated by the continuing low price of oil and the effect this is having on the industry and its supply chain.”

Swinney put the growth in the service sector in part down to strong performances in accommodation and food and retail and wholesale, while he mentioned major public infrastructure projects such as the Queensferry Crossing as underpinning the growth in construction.

However, Scottish Liberal Democrat leader Willie Rennie said: “Today’s figures will send a worrying shiver down the spines of business across Scotland. Scottish economic performance is falling back behind the rest of the UK despite the promises from SNP ministers.

“The detailed data shows the need to broaden the economic performance of the economy and the Scottish Government must do more to help start-up businesses.”

Survey data for the Bank of Scotland in December also reported modest expansion in the service sector for the third month in a row, but a decline in the manufacturing sector.

The Scottish Chambers of Commerce (SCC) recently published its quarterly economic survey for the fourth quarter of 2015, in collaboration with the Fraser of Allander Institute at the University of Strathclyde, on the business performance and outlook in five key Scottish sectors: construction, finance and business, manufacturing, retail and wholesale, and tourism.

Construction and manufacturing businesses showed strong results, tourism was mixed, but less strong than it has been in the same quarter of the previous year, and the business and finance and retail and wholesale sectors both declined.

In construction 55.3 per cent of firms reported an increase in sales and 41.3 per cent saw an increase in profits. However, many experienced difficulty in recruitment. In manufacturing 41.2 per cent of firms had an increase in orders during the fourth quarter.

However, in business and finance 44.7 per cent of businesses saw a decrease in sales and 46.7 a decrease in profits and in retail 44 per cent of businesses saw a drop in sales. Tourism was more mixed, with 47.8 per cent of firms reporting an increase in guests, but with a drop in visitors from outside the UK, recruitment issues and a decrease in optimism.

Business optimism was down overall on the previous year. The SCC report explained: “Low levels of optimism may be due to a significant number of firms citing concerns regarding the impact that the Living Wage, low oil prices and business rates will have on their business.”

It puts the poor performance of the finance and business sector down to the low global market price of oil, adding that the ongoing decline in world oil prices now also appears to be affecting businesses outwith the oil sector.”

Commenting on the figures in the report, Liz Cameron, the director and chief executive of Scottish Chambers of Commerce, said: “Our latest Economic Indicator points to continued success for many businesses, but the shadow of the continued decline in global oil prices now looks to be extending beyond those businesses operating directly in the sector.

She added: “Last year, the Scottish construction sector was one of the primary drivers of growth. This remained the case right up until the end of 2015 and despite the fact that optimism in the sector is less strong than it was a year ago, prospects for employment in the sector remain positive.”

However, she noted it is one of a number of sectors where businesses are facing skills shortages, with nearly two-thirds of firms having experienced difficulties in recruiting. 

“Businesses are telling us that they are looking for education and skills providers to be developing the talents that industry needs,” she said. Too often an upturn in business activity is not matched by a commensurate increase in the availability of skilled workers.”

On manufacturing, she said: “Despite a slowdown in exports, there remain some grounds for optimism for Scotland’s manufacturers, many of which recorded a broadly positive end to 2015.  Both revenues and orders remained in positive territory, but expectations are for investment to ease in the early part of 2016.”

Apart from the repeated raising of oil figures in recriminations about what would have happened had Scotland voted yes to independence, the price of oil is a matter of grave concern for the Scottish economy, particularly in the North East.

Last week, BP announced 600 job losses in Scotland over the next two years. According to its September 2015 report, it employs 3,600 people directly in Scotland, mainly in Aberdeen and Shetland, contributing £430m to GVA.  It estimates that it indirectly supports 47,000 jobs in Scotland through capital expenditure and purchasing goods and services from suppliers.

Due to oversupply in the world markets, the price of Brent crude plummeted to less than half from its peak value of $110 a barrel in June 2014 to $48 a barrel by January 2015, and falling to close to $30 a barrel in January 2016, with some commentators suggesting it may drop even lower.

Industry body Oil & Gas UK reported that the volume of UK oil and gas produced was up 8.6 per cent in the first 10 months of 2015 - the first rise in oil and gas production for 15 years - but chief executive Deirdre Michie predicted the industry would be “extremely challenged” to continue this into 2016.

The Scottish Government’s energy jobs taskforce estimated in its September 2015 progress report that more than 6,000 jobs had been lost or were at risk through redundancy.

Energy Minister Fergus Ewing said: “Given the challenges presented by lower oil prices and an increasingly complex operating environment, a key role for government will be to ensure that the fiscal regime is stable, predictable and that headline tax rates in the UK Continental Shelf remain internationally competitive.”

Meanwhile the Federation of Small Businesses (FSB) reported that its Small Business Index had fallen to 1.7 points in Q3 of 2015, down from 26 points in the same quarter of 2014, but “a positive balance” of firms expected business conditions to improve over the coming three months.

“This suggests that economic growth among small businesses is likely to continue on a steady pattern, rather than picking up rapidly or falling back.” It warns, though, that the “current recovery remains on a relatively fragile footing” and “a small shock could send things off balance and see more difficult business conditions re-emerging.”

Business conditions were not helped by the recent closure of the Forth Road Bridge and unprecedented flooding. The Road Haulage Association has estimated that the Forth Road Bridge restrictions are costing the road haulage industry £600,000 per day and that if heavy goods vehicles are unable to use the bridge until February, the total industry costs could be in excess of £40m. The impact on the wider economy will be much greater than that.

Insurance company PwC estimates that the total economic losses as a result of the three storms Desmond, Eva and Frank could exceed £3bn across the UK. It notes: “There could be further potential economic fallout for the UK due to the fact that SMEs help drive the economy and the impact on their ability to trade will have a knock-on effect on UK GDP.”

The outlook is more positive in other areas, though. Tourism figures have remained buoyant, with tourism GVA up 34 per cent over five years, according to VisitScotland. There were 15.5 million overseas and domestic visitors to Scotland in the year to September 2015, a rise of seven per cent, and for the first time total expenditure was over £5 billion, rising eight per cent.

In the food and drink sector there has been a 35 per cent rise in Scottish food and drink brand sales in the UK. Exports reached £15.1bn in 2014, and the industry has set itself the stiff target of increasing exports to £17.1bn by 2017.

The Scotch Whisky Association (SWA) reported that a decline in exports seemed to be slowing, with exports in the first half of 2015 worth £1.7bn. The volume of exports was down by half of last year’s decline, falling just under 3 per cent, and exports to the USA, the biggest market for Scotch whisky remained steady, while exports to Mexico were up nearly 12 per cent, China by 46 per cent and Japan by 7.2 per cent.

“Encouraging trends are starting to develop in several key markets despite continuing economic headwinds, political uncertainty in some parts of the world, and the impact of a stronger pound sterling in many areas,” the SWA said.

Scottish salmon, Scotland’s biggest food export is in a similar situation. The strong pound is making exports challenging, but production has increased year-on-year and demand continues to outstrip capacity to supply.

In housing, the RICS is predicting that house prices will rise by four per cent and the cost of renting by three per cent in 2016.

Simon Rubinsohn, RICS Chief Economist, commented: “Housing has clearly leapt up the government’s agenda but despite the raft of initiatives announced over the past year, the lags involved in development mean that prices and for that matter, rents, are likely to rise further over the next twelve months. Lack of stock will continue to be the principal driver of this trend but the likely persistence of cheap money will compound it for the time being.

“Looking further out, there is some justification for taking a more optimistic view of new build with significant incentives being put in place to deliver starter homes,” he added.

“While this may not on its own stem the upward trend in house prices, it could help to slow the rate of growth to something closer to the probable rise in household incomes.”

Forecasts for the UK economy as a whole predict around 2.3 per cent growth in 2016. Researchers at the Fraser of Allander Institute have forecast that the Scottish economy will grow by 2.2 per cent in 2016. They say the Scottish economy has begun to diverge quite markedly from the UK and see that as a cause for concern that needs to be addressed.

“Scotland’s weak productivity and poor export performance necessitates that the Scottish Government tackle these issues more directly if it is to raise the long-term growth rate of Scotland’s economy,” said Professor Brian Ashcroft, professor emeritus at the Fraser of Allander Institute.

However, the Scottish Government’s 2016/17 budget looks unlikely to cause too many ripples in the economy. Grahame Smith, general secretary of the STUC, described it as “a hold steady budget designed not to frighten the horses in advance of next year’s Scottish Parliament elections.”

Although the Scottish Government has the ability to set a Scottish rate of income tax for the first time, it chose not to diverge from the UK rate for the next financial year because at present it only has power to raise or lower all three tax bands by the same percentage. In presenting the budget, John Swinney said he would not use the power as it would disproportionately affect those on the lowest incomes.

“We recognise that to support the public services we all rely on we must ensure that our tax policies are built on the principle that the tax burden should be proportionate to the ability to pay,” he said.

The only really controversial aspect of the budget was a decision to reduce funding to local government by £350m or 3.5 per cent while continuing the council-tax freeze for the ninth year in a row, which COSLA described as “totally unacceptable”, saying it would cost 15,000 jobs, while Inverclyde Council leader Councillor Stephen McCabe asked, rhetorically, where the local government taskforce was. “In any other industry there would be a huge outcry,” he said.

More dramatically, last week one council, Moray, indicated that it may defy the Scottish Government to raise council tax by 18 per cent.

But in general, the economic atmosphere in Scotland seems to be one of wait and see. Wait until the Scotland Bill is passed and we see what the fiscal settlement is. Wait and see what the parties propose doing with their new powers when they produce their manifestos. This year is one of holding out, next will be one of increase – an increase in powers, certainly; an increase in taxes, maybe. But will this lead to an increase in growth?

The most interesting developments in the Scottish economy will be from hereon in, and there are both opportunities and risks. It may not be, as David Mundell said, Scottish Parliament 2.0, but it is at least 1.2. Even though the Scottish rate of tax is to be the same as the UK rate for 2016/17, this does not entirely mitigate the increased risk carried with the devolved power. Whereas the block grant was a fixed amount, variations in the Scottish economy will in future directly affect revenues.

And more powers are to come under the Scotland Bill. How the parliament will use these new powers will be interesting to see. While there is no requirement that any future Scottish Government differs from the UK Government, having fought so hard to gain more autonomy for Scotland, it will be difficult for any party other than the Conservatives to justify making no change at all.

There is within these powers the possibility for Scotland to become financially very different from the rest of the UK. With the new powers are the ability to vary not just the level of income tax in Scotland across the board, but also the bands, thresholds and rates. And with the likelihood that council tax in Scotland will be changed to a more progressive system following the Commission on Local Tax Reform’s report in December too, the Scottish fiscal landscape could look very different in five years’ time.

While Scots, traditionally, have supported more progressive taxation in theory, if both local and national taxation becomes more progressive, charging the better off more, will this still be as popular when it comes to actually putting hands in pockets?