JEREMY PEAT
The UK General Election will be done and dusted this week, and perhaps then we can return to the key task of managing, and seeking improvement in, the Scottish economy – after a seemingly endless period when politics predominated over all else. Even as I write those words I knew that this is a hollow hope. In the months ahead we face a continuing debate over Brexit – how, when, etc. – and perhaps months of uncertainties over the prospect of a second referendum on independence.
However, the Scottish economic outlook is poor; and in addition a massive amount of work is required from Government, Parliament, its advisers and other analysts to deal with the implementation of the new fiscal framework and achieving what the Auditor General has called a needed ‘transformational change’ in Parliament’s scrutiny of the Scottish Budget. Key efforts should be directed towards enhancing the outlook and managing the change required in our fiscal processes and public finance choices. Given that the implementation of Brexit must also be seen as critical for our economic future, the pressures on all will be massive in the months ahead.
The UK economic outlook is at best problematic. While employment keeps rising and unemployment falling – both most welcome – this is against a backcloth of rising inflation and stagnant wage growth. After the 2008 recession we experienced an extended period of declining real wages – average earnings rising more slowly than inflation. After two or three too brief years of increasing real earnings we have now reverted to that post-recession trend.
Average earnings are rising by only just over two per cent per annum, while inflation is heading up towards three per cent. This pattern is set to continue through 2017 and into 2018, and means growing pressure on households’ expenditure. Levels of household credit are already (too?) high and there is a risk of interest rates rising (at long last) later in the year. Consequently consumption growth will stall – dragging down the rate of growth of the economy as a whole. That will cause problems at the UK level, where growth in Q1 was down to 0.2 per cent, but even more so in Scotland, where our last recorded GDP growth measure showed decline in the last quarter of last year.
Two more causes for concern must now be added to the list. First, I return to a recurring theme – productivity. Contrasting two recent pieces of UK data displays our problem. As noted above UK GDP grew by only 0.2 per cent in Q1. For the same period, given the very positive labour market data again noted above, the total number of hours worked rose by 0.8 per cent. Therefore, output per man hour fell back sharply. Indeed on this measure productivity is back close to its pre-2008 level. The latest Scottish data show that output per hour worked declined by 1.5 per cent in real terms in 2016. There is no sign of a change in this adverse trend and our productivity relative to key competitors continues to decline.
Then there is the massive unknown which is Brexit. The impacts to date have included the sharp depreciation of sterling, resulting in higher inflation and declining real incomes, and a knock to business investment (domestic and inward) due to the uncertainties. We still have no real idea as to what the impact of actual Brexit will be, either on the real economy or the public finances. Neither will be pretty, at least in the short to medium term.
The gung-ho Brexiteers believe that the UK will flourish in some Utopian world of free trade with all of the rest of the globe. However, two points provide further cause for concern. First there is no guarantee that the required free trade agreements with EU, USA, China, India, et al will be forthcoming – and if they are this will be with marked delays. Second, given the UK – and Scotland’s – very weak performance on productivity many companies will struggle to compete globally even if the appropriate agreements are reached.
Come what may Brexit will have adverse economic implications in 2018 and 2019, and the scope for faster growth of incomes and wellbeing over that period looks marginal in the extreme. That is why we must work through the causes of low productivity and seek out every means of reversing the adverse trend. This will take time; so delay will bring real costs.
In addition to these key tasks, policy makers will also need to assess a variety of Brexit implications. Not least will be determining which (presently) EU responsibilities can and should be returned to the Scottish – rather than UK – Parliament; and how can it be assured that the appropriate funds are transferred with those powers. Examples include agriculture and fisheries support; research funding; and resources for economic development. Nothing trivial!
The new fiscal framework now being introduced for Scotland simply adds to the complexities – and the risks and uncertainties. As Graeme Roy of the Fraser Institute has stated this is the ‘biggest reform to the financial powers of the Scottish Parliament since 1999’ and the changes ‘will not only be fundamental for how public services are funded in Scotland but also for our future economic prospects’. We are moving from what Jim Mather called ‘a house-keeping Budget’ (deciding what to do with funds provided from elsewhere) to one where some 50% of expenditure will be funded from revenues raised in Scotland.
Government and Parliament, thankfully advised by the strengthened Independent Scottish Fiscal Commission, will have to worry about raising revenues as well as spending; and to a considerable extent the funds available will be contingent upon Scottish economic performance. Funds will inevitably be scarce and the poorer our economic performance, both in absolute terms and relative to the rest of the UK, the scarcer the funding and the tighter the constraints on expenditure.
No wonder my key message is let us focus now on what matters!
Jeremy Peat is visiting professor at the University of Strathclyde International Public Policy Institute.
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