What are the economics of Scottish independence?

Yesterday saw the First Minster of Scotland fire the starting gun for a second vote on independence from the UK for Scotland as the pace of possible change ratchets up yet another notch. With it came am intriguing view of how long a lifetime is these days! Although I am also reminded of the saying that “a week is a long time in politics”. However as ever I look to steer clear of the political melee and look at the economics. So how is the Scottish economy doing?

Economic growth

The Scottish government has published this data.

When rounded to one decimal place, at 2016 Q2 annual GDP growth in Scotland was 0.9 percentage points lower than in the UK. At 2016 Q3, annual GDP growth in Scotland was 1.2 percentage points lower than in the UK. Between 2016 Q2 and 2016 Q3, the gap between annual Scottish and UK GDP growth increased by 0.3 percentage points in favour of the UK (when rounded to one decimal place).

As you can see the recent performance has been around 1% per annum slower than the UK and may well be accelerating. With the UK economy overall having grown by 0.7% in the last quarter of 2016 that seems likely to have continued but of course there are always dangers in any extrapolation. If we look back we see that in the pre credit crunch period GDP growth was similar then Scotland did worse and then better as presumably the oil price boom benefited it ( although the oil sector itself is excluded). Then until the recent phase Scotland did mildly worse than the rest of the UK.

Looking ahead

The Scottish government plans to improve this and with an eye on future policy has set a European Union based objective.

To match the GDP growth rate of the small independent EU countries by 2017.

How is that going so far?

The latest data show that over the year to 2016 Q3 GDP in Scotland grew by 0.7% whilst GDP growth in the Small EU was 3.5% (measured on a rolling four quarter on four quarter basis). When rounded to one decimal place, this resulted in a gap of 2.8 percentage points in favour of Small EU. This compares to an annual increase in GDP to 2016 Q2 of 1.0% in Scotland, and an increase of 4.2% in the Small EU – resulting in a 3.3 percentage point gap in favour of Small EU (when rounded to one decimal place).

As you can see the gap here is much wider and leaves Scotland with a lot of ground to recoup. If you look at the list that may well get harder.

The small independent EU countries are defined as: Austria, Denmark, Finland, Ireland, Portugal and Sweden. Luxembourg has been re-included in the newest update due to a change in availability of data.

Ireland is proving a hard act to follow.

Preliminary estimates indicate that GDP in volume terms increased by 5.2 per cent for the year 2016. GNP showed an increase of 9.0 per cent in 2016 over 2015.

It is an awkward fact that the 21% economic growth registered by Ireland in the first quarter of 2015 lifted the target away from Scotland and it continues to offer something hard to catch. Of course such large moves also challenge the credibility of the Irish data series.

What about employment?

Good but not as good as England currently.

Scotland’s employment rate of 73.6 per cent for Q4 2016, is the second highest across all UK countries, 1.3 percentage points below England. This indicates a worsening position compared with a year ago when Scotland had the highest employment rate across all UK countries, 0.2 percentage points above England (the second highest).

Natutral Resources

Crude Oil and Gas

Plainly Scot;and has considerable resources here although unless there are new discoveries these seem set to decline over time. There have also been big changes in the crude oil price as FullFact reported last October.

It is correct that crude oil prices are currently at around $50 a barrel. Back at the time of the first Scottish independence referendum in September 2014 oil was selling for just over US $90 a barrel.

Energy policy, and how oil revenue would be invested, was part of  the Scottish government’s vision for an independent Scotland……….”With independence we can ensure that taxation revenues from oil and gas support Scottish public services, and that Scotland sets up an Energy Fund to ensure that future generations also benefit from our oil and gas reserves. “

I think that FullFact were being very fair here as there were forecasts from Alex Salmond that the oil price would rise towards US $130 per barrel if my memory serves me right. Whereas it is now US $51 or so in terms of Brent crude oil. So the oil sector has seen something of a recession affecting areas like Aberdeen although there would have been gains for other Scottish businesses and consumers from lower prices.

The Fiscal Position

This has been affected both by the lower oil price and also by the recent trend to lower economic growth than the rest of the UK. The former was highlighted by this from the 2015-16 data.

Scotland’s illustrative share of North Sea revenue fell from £1.8 billion in 2014-15 to £60 million, reflecting a decline in total UK North Sea revenue.

This led to these numbers being reported.

Excluding North Sea revenue, was a deficit of £14.9 billion (10.1 per cent of GDP).

Including an illustrative geographic share of North Sea revenue, was a deficit of £14.8 billion (9.5 per cent of GDP).

For the UK, was a deficit of £75.3 billion (4.0 per cent of GDP).

This adds to an issue I reported on back in my Mindful Money days in November 2013.

So there is something of a shark in the water here. If we add in the fact that Scotland spends more per head than the rest of the UK then the IFS ( Institute for Fiscal Studies) considers that the fiscal position is more dangerous. Both the UK and Scotland spend more than they get in from tax but the Scottish position is more reliant on a fading source of tax revenue. This is what leads to the following conclusion.

As it turns out that source of revenue has ended at least for now and seems to be capped by the shale oil wildcatters for the next few years. All rather different to this.

But a current strength of the numbers is revenue from North Sea oil which was 18.6% of tax revenue in 2011-12 for Scotland.

Of course there would be quite a debate over the share of the UK national debt that would belong to Scotland but the fiscal position is presently poor.

What currency?

This poses a few questions so let me repeat the issues with using the UK Pound.

1. The Bank of England will presumably set interest-rates to suit England (and Wales and Northern Ireland). This may or may not suit Scotland.

2. The value of the pound will mostly be determined by the much larger English economy in some respects similar to the way that Germany dominates the Euro. That has not worked out well for many of the Euro nations.

3. This is to say the least awkward, if further bank bailouts are required. Will the Bank of England be the “lender of last resort” in Scotland? How does this work when it has an independent treasury? Just as a guide, individual nations in the Euro area had their own central banks which survive to this day partly because of this issue.

4. There is also the issue of currency reserves and intervention which presumably also stay with the Bank of England.

5. What about the money supply of Scotland which will again presumably be controlled by the Bank of England and set for the rest of the UK?

6. Has anybody bothered to ask the citizens of the rest of the UK if they are willing to take the risk of having Scotland in a currency but not a political or fiscal union? This would take place just as the Euro is demonstrating many of the risks of such an arrangement. But added to it for the rest of the UK would be new oil or gas discoveries pushing up the value of the pound and thereby making their businesses and industry less competitive.

Comment

Scotland plainly has economic strengths with its natural resources and financial services industry. However since the last vote there has been a deterioration in economic circumstances as we have seem growth fall below that of the rest of the UK. This has led to a problem with the fiscal deficit and it is hard not to think of the criteria for joining the European Union.

New Member States are also committed to complying with the criteria laid down in the Treaty in order to be able to adopt the euro in due course after accession.

We do not know what the national debt would be but the fiscal deficit is around treble the 3% of GDP target per annum in the Euro accession rules. Of course Euro members have often ignored it but they have been much stricter on prospective entrants. Quite a Euro area style austerity squeeze would seem likely and that has been associated with recessions and quite severe ones at that.

Charlotte Hogg’s Resignation

Back on the 1st of March I pointed out the lack of competence on monetary policy she displayed in front of the UK Treasury Select Committee. Today it was announced that she offered to resign last week but Mark Carney would not take it. Now he has.

http://www.bankofengland.co.uk/publications/Documents/news/2017/charlottehoggletter130317.pdf

 

http://www.bankofengland.co.uk/publications/Documents/news/2017/028.pdf

 

 

 

What is the economic and fiscal situation in Scotland?

Yesterday brought us some new information on the economic situation in Scotland as the government there published its latest public finance data and updated us on the economic growth situation. So let us go straight to the GDP data.

In quarter 1 2016 the output of the Scottish economy was flat (0.0 per cent change), following growth of 0.3 per cent in quarter 4 2015. Equivalent UK growth was 0.4 per cent……Scottish GDP per person was also flat during the first quarter of 2016.

So an underperformance compared to the rest of the UK which in fact is something that can also be seen if we look back over the previous year.

Compared to the same period last year (i.e. quarter 1 2016 vs quarter 1 2015), the Scottish economy grew by 0.6 per cent. Equivalent UK growth was 2.0 per cent.

If we look back we see that the Scottish economy had a similar pattern to the rest of the UK in that economic growth pushed up to between 2% and 3% and in fact for a while did better. But since the beginning of 2015 economic growth has been slip-sliding away which has a cause you are probably already thinking of but please indulge me and hold your horses as there are complications.

Scotland’s economic structure

This is different to the rest of the UK as shown by the numbers below.

Scotland’s economy is broken down into four weighted industry categories. The breakdown for 2013 is services (75 per cent), production (18 per cent), construction (6 per cent), and agriculture, forestry and fishing (1 per cent).

So agriculture is a little higher but the main change compared to the UK numbers below is more production and  a smaller services sector.

The current 2013 – based weights are: services 78.8%; production 14.6%; construction 5.9%; and agriculture 0.7%.

You might be thinking that the production numbers should be even higher but the numbers we are given are on this basis.

This publication presents results for what is commonly referred to as the “onshore economy”, which means they exclude oil and gas extraction activity in the North Sea.

I have looked these up as they are in the overall UK numbers.

Within the production sub-industries, output from mining and quarrying, including oil and gas extraction, decreased by 2.3%;

However on an annual basis the picture was much brighter.

Mining and quarrying, including oil and gas extraction, increased by 5.3%,

For those wondering how this can be with the oil price where it is I have checked before and the numbers have been affected by past maintenance shut-downs.

Whilst the explicit oil and gas output numbers are removed there are still implicit effetcs from the industry as towns like Aberdeen depend to a large degree on it. Over the past year the break down of Scottish economic growth is shown below.

The growth in Scottish GDP in this period was due to the tail end of growth in the construction industry plus growth in the services industry (particularly distribution, hotels and catering), tempered by contractions in the production industry (particularly manufacturing).

I would be interested in readers thoughts and explanations of the construction boom. In terms of the numbers it seems to have been affected by the ESA 10 methodological changes which pushed it higher.

Construction output saw extremely strong growth in 2014 and 2015 and drove much of GDP growth over this period

The Fiscal Position

Yesterday saw the publication of the GERS dataset which estimates the revenue and public spending situation for Scotland. If we start with the revenue situation there is something glaring in the numbers.

Including an illustrative geographic share of North Sea, Scottish public sector revenue was estimated as £53.7 billion (7.9 per cent of UK revenue). Of this, £60 million was North Sea revenue.

As you can see the North Sea is not ignored here and the last sentence is not a misprint.

Scotland’s illustrative share of North Sea revenue fell from £1.8 billion in 2014-15 to £60 million, reflecting a decline in total UK North Sea revenue.

Ouch! This means that the individual position is as follows.

Scotland’s public sector revenue is equivalent to £10,000 per person, £400 less than the UK average, regardless of the inclusion of North Sea revenue.

Just to show how times change this is what we were told about 2011/12.

In 2011-12, oil and gas production in Scottish waters is estimated to have generated £10.6 billion in tax revenue, 94% of the UK total…….Total tax revenue (onshore and offshore) in Scotland was equivalent to £10,700 per person in 2011-12, compared to £9,000 in the UK as a whole.

Expenditure

The situation here is of higher public expenditure per person compared to the rest of the UK which is an example of regional policy in action.

Total expenditure for the benefit of Scotland by the Scottish Government, UK Government, and all other parts of the public sector was £68.6 billion. This is equivalent to 9.1 per cent of total UK public sector expenditure, and £12,800 per person, which is £1,200 per person greater than the UK average.

The Fiscal Deficit

The situation here is that Scotland is receiving the large fiscal stimulus that is being recommended by some for the rest of the UK although to be fair there have been very few suggesting one of the size below. Also at current oil prices it is noticeable how little difference North Sea Oil & Gas makes.

Excluding North Sea revenue, was a deficit of £14.9 billion (10.1 per cent of GDP)….Including an illustrative geographic share of North Sea revenue, was a deficit of £14.8 billion (9.5 per cent of GDP).

This compares to an overall UK position of.

For the UK, was a deficit of £75.3 billion (4.0 per cent of GDP).

Comment

If we stick to the economics we see an economy that is suffering from a fall in price of a natural resource that it produces. Whilst the GDP data excludes the oil & gas sector explicitly there are clear implicit effects and the fiscal position has been hit hard. However it has been shielded to some extent by its membership of the UK. This comes in various forms. Firstly the regional policy I mentioned earlier. Next we have the fact that it does not have its own currency as a Sottish Pound would presumably have been hit hard or at least a lot harder than the UK Pound has been post Brexit!Indeed there would have been very wide swings in the value of a Scottish Pound. Also a stand-alone fiscal deficit of that size would see the debt vigilantes looking to party even in these hard times for them. I do realise there are so many ironies here but as part of the UK Scotland can borrow much more cheaply than it would on its own. Oh and Bank of England policy seems much better suited to the Scottish economic situation assuming you believe that more monetary easing is a stimulus. Finally there is the size of the fiscal deficit itself which is a substantial stimulus.

Meanwhile as a sign of ch-ch-changes I would like you to join me in a journey in Doctor Who’s TARDIS back to March 2013 when we were told “the balance of risk being on the upside” for oil prices by the Scottish Government leading to this.

analysis published by the OECD in March 2013 suggests that rising demand in East Asia and continued tight supply could result in oil prices rising above $150 by 2020…….could result in oil and gas production in Scottish waters generating £57 billion in tax revenue between 2012-13 and 2017-18

Let me remind you of the words of the late and great Yogi Berra.

The future ain’t what it used to be.

 

 

The Bank of England is switching to expect ever lower inflation

There is much to consider in the world of inflation and inflation trends in the UK but let me first open with something which is eating away at the credibility of official UK statistics. From the UK Statistics Authority on the 22nd of January.

I note that an indication of the substance of Wednesday’s Labour Market Statistics release was shared by the Department for Work and Pensions (DWP) with up to 300 people, through a social media network ahead of the publication of the report by someone who is not approved to have pre-release access to the statistics.

This is a serious matter as nothing is more corrosive to financial markets than a lack of trust and once lost trust is a very difficult thing to regain. The structure of the UK system is that there is a list of people such as the Prime Minister and the Governor of the Bank of England who receive important statistics 24 hours early so they can be prepared. However the numbers have changed and now include Special Advisers or Spads. Somewhere on this road there seem to have been more than a few incidents of some traders being more equal than others or an “early wire”.

I raise this because this morning there have been suspicions of such action from those trading the UK Pound. Now here is the thing this still matters if they are wrong because the situation is that such complaints are believed. Of course it is even worse if they are true.

Official inflation trends

Yesterday we learned what the German Bundesbank thinks of the prospects for inflation in 2016. From Bloomberg.

Consumer-price growth in Europe’s largest economy will now average approximately 0.25 percent in 2016, down from a December prediction of 1.1 percent, the Frankfurt-based central bank said in its monthly bulletin published on Monday. For 2017, the forecast was cut to 1.75 percent from 2 percent.

This matters as whilst the 2016 change is eye-catching it is the 2017 one that really matters as at the policy horizon inflation is below target. So even the Bundesbank is hinting at a policy easing and we can expect the European Central Bank to do the same as a lower oil price and higher Euro will do the same to it. Oh but we do get an implied critique of official forecasts and forward Guidance as the ones which have just been slashed were only compiled in December.

Much of the analysis above applies to the UK as well and we saw a hint of that yesterday as one Bank of England member folded like a deck chair. From Reuters and the emphasis is mine.

Speaking to the Wall Street Journal, McCafferty, who dropped his lone call to hike interest rates earlier this month, said the central bank was not “out of ammunition” if it needed to fight a renewed downturn by cutting interest rates or restarting its bond-buying programme.

Will down be the new up?

This is particularly awkward for Ian McCafferty who has now twice started series of votes for an interest-rate rise before collapsing like a pack of cards. He is living up to his old City nickname of “as expected” which as you will be aware becomes a nickname when it invariably is not true.

Today’s inflation data

This links into the current driver of inflationary trends pretty much directly. From the Office for National Statistics.

The all items CPI annual rate is 0.3%, up from 0.2% in December…… The largest upward contribution to the change in the 12- month rate came from prices for petrol, which dropped by 1.9%, compared with a larger fall of 7.3% between the same 2 months a year ago. A similar, though less pronounced, effect was seen for diesel, with prices falling by 4.0%, compared with a fall of 6.0% a year ago;

Yes it was a follow-on effect of lower oil prices although we see that they in fact fell more slowly than last year rather than rose. So it was the oil price which is in the news again today after its recent strong rally in percentage terms albeit of course on a much lower price. The OPEC news as I type this is summarised by Neil Hume of the Financial Times as follows.

In summary then Russia and Saudi Arabia are willing to freeze production at or near record levels. Fantastic news for glutted market.

We will see how that plays out but there is another way of looking at today’s inflation numbers.

The all items CPI is 99.5, down from 100.3 in December.

If you want something that looks even more disinflationary then there is this sector.

The CPI all goods index is 98.5, down from 99.3 in December…….The CPI all goods index annual rate is -1.5%

The other side of the coin is services inflation which is at 2.3% although even there the underlying index fell from 101.5 to 100.7.

Number Crunching

It is rarely explained that one of the reasons that UK inflation has gone to a lower trajectory is that the definition was “improved”. Rather than a complex explanation let me show you the difference between the old official measure of inflation and the new one.

The all items CPI annual rate is 0.3%…..The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs) index, is 1.4%,

As you can see there is a 1.1% difference which if you look at the economic world right now makes an enormous difference. If you want precision well here it is.

The difference between the CPI and RPI unrounded annual rates in January 2016 was -1.02 percentage points,

This is an  important issue as it drives at how we account for housing costs and in particular owner-occupied housing costs which are a particularly important issue in the UK. You see the official CPI measure does the equivalent of sticking its head in the sand on the issue. Whilst there are problems with the RPI I would point out that even the new version is moving away from CPI.

The all items RPIJ annual rate is 0.7%, up from 0.5% last month.

At least some of the “deflation” paranoia exhibited in so many places over the past year or so is due to a lazy ignorance about a type of stealthflation style change to how it is measured.

House prices

Here is the nub of UK inflation measurement where there is plenty of inflation to be seen which many will think is exactly why official statisticians ignore it.

UK house prices increased by 6.7% in the year to December 2015, down from 7.7% in the year to November 2015.

Not quite as fast as last month but still around treble the rise in real wages we expect. So a factor in affordability continues to decline which is of course why first time buyers need so much “Help”. The Resolution Foundation has looked at this from another direction today.

The new official effort is to use rental costs and then neuter them as much as they can this leads CPIH to be 0.6%. Mind you it has been at best a shambles.

CPIH is currently undergoing re-assessment

Scotland

I noted this in today’s numbers which highlighted a different pattern.

There was a 0.2% decrease in average house prices in Scotland (down from a 1.2% increase in the year to November 2015).

If we look deeper we see signs of a decoupling from the pattern in the rest of the UK.

the index for Scotland in December 2015 (226.7) is 6.8% below the record level witnessed in March 2015 (243.2) – Scotland prices are now 1.7% below the pre-economic downturn peak of June 2008 (230.6)

Is this the impact of the falling oil price on Aberdeen or something deeper?

Comment

The underlying inflation picture continues apace. Good prices have been driven lower and have sucked the official inflation measure down to around zero. On the other side of the coin services inflation ( CPI 2.3% or RPI 2.4%) continues to be over the target. For us to remain here oil and commodity prices need to continue to fall which is possible if you look at OPEC but the large falls are behind us.

So you would think that central banks would be adjusting for higher inflation at the policy horizon. But in fact they are doing the reverse as we see the Bundesbank in effect giving Mario Draghi licence to ease again and Ian McCafferty the supposed hawk at the Bank of England talking of interest-rate cuts. Forward Guidance anyone?

Meanwhile under the radar something is happening to Scottish house prices at a time where it is hard to think of monetary policy being more supportive.